Nifty surged on hopes of early RBI rate cuts and a pause of Gaza war

Considering the present trend of India’s core inflation and the Indian general election, RBI may cut from Feb’24

India’s benchmark stock index Nifty closed around 19425.35 Friday, surged almost +2.00% in the last two weeks on the easing of Gaza war tensions (from becoming a wider regional conflict involving Iran), progress of ceasefire negotiations, and hopes of Fed/RBI pause/pivot. On Friday, both Wall Street and Dalal Street were boosted by 4-hour humanitarian pauses for every day in the Gaza war and the increasing possibility of a 3-day ceasefire for the release of some (10-15) hostages.

On Thursday, U.S. President Biden said he was still pushing for longer pauses in Gaza to get captives released. But Biden’s request for a longer humanitarian pause was rejected by the Israeli PM. Overall, both Israel and the U.S. are under pressure globally and locally for the current stance of using excessive force without caring for the hostages/captives, even after considering the self-right of Israel to eliminate Hamas to ensure durable peace and safety for its citizens.

Overall, Israel/IDF is now in the process of securing/controlling Gaza City completely including hospitals and other suspected hideouts of Hamas, and may officially announce by Monday/weekend the full control of Gaza City and subsequent Ceasefire for at least 3-days for release of 10-15 hostages. U.S. CIA Director is personally involved in the overall negotiation process with Hamas through Qatar mediation and the backdoor negotiation is very active.

 As per some Israeli media reports Sunday there was some progress toward a deal to free captives held by Hamas in Gaza. Israel’s PM Benjamin Netanyahu said he would not discuss details of any possible deal, which may involve 50 to 100 women, children and elderly people being released in stages during a three-to-five-day pause in fighting. According to the reports, Israel would release women and minor Palestinian prisoners and consider letting fuel into Gaza, while reserving the right to resume fighting.

Wall Street was also undercut by a more hawkish than expected speech by Fed’s Chair Powell Thursday, keeping options open for at least another rate hike if U.S. core inflation does not come down adequately and the economy runs hotter than expected. Powell also indicated no early rate cut in 2024, at least till H1CY24.

But all these Fed stance of hawkish hold is already known/discounted by the market to a great extent. Going by the current and expected sequential run rate, U.S. Core CPI should average around +3.0% by Dec’24 and +2.0% targets by Dec’25. Thus Fed may cut -50 bps in H2CY24 (September and December) to +5.00% repo rate and keep the real rate around +2.00%. And if core CPI indeed falls below +3.0% in early 2025, then the Fed may go for a -2.00% cumulative cut in 2025 (-50 bps in each quarter) for -3.00% repo rate and further -50 bps in 2026 for longer-term repo rate +2.50%. In the longer term, the Fed may keep the real repo rate at around +0.50%.

Now from Wall Street to Dalal Street, India’s RBI is also on a hawkish hold stance till at least June’24 and may also go for rate cuts from August-September’24 in line with the Fed to keep interest rate/policy differential at par to manage USDINR and imported inflation and growths/exports. By June’24, India’s core CPI should also fall below +5.0%, paving the way for an RBI rate cut. But RBI may also go for pre-emptive rate cuts from Feb’24, just ahead of the general election to boost up stock market and general public/consumer confidence.

India’s core CPI further eased to +4.5% in Sep’23 from Jan’23 and 2022 average levels of +6.1%. Now the 2023 average core CPI is around +5.0% and at a present run rate, core inflation may stabilize around +4.50% by June’24. Although it may again surge/edge up in Q3CY23 amid elevated consumer demand during Oct-Dec’23 festival period, especially service inflation (leisure & travel) and also selected category of goods inflation (as producers still have ample pricing power), considering global trend, lower oil, higher base effect, improvement in supply chain bottlenecks observed during COVID and higher borrowing costs, both headline and core inflation should ease substantially in 2024.

On 9^th November, RBI Governor Das said in a prepared speech at the Tokyo (Japan) Symposium on Indian Economy 2023: Emerging India: A Land of Stability and Opportunities

The global economy continues to face multiple macroeconomic and geopolitical shocks. The prediction of a global recession has not come true but there are indications that global growth is slowing down amid tightening financial conditions and still elevated inflation. Even as the fallouts of the pandemic, the war in Ukraine, and the unprecedented tightening of monetary policy reverberate across the world, the recent developments in West Asia have added to the litany of challenges for the global economy.

Policymaking in this scenario becomes extremely challenging with difficult trade-offs – growth versus inflation; price stability versus financial stability; and current exigency versus future sustainability. There is always a risk of doing too little or doing too much. In such a scenario, I would like to start with the Reserve Bank of India’s approach to policymaking during this turbulent period.

Our Approach

To protect the economy from the relentless shocks in the recent period, we have endeavored to remain proactive, pragmatic and prudent in our policy response. We were conscious of the fact that an overdose of monetary medicine while relieving the pain in the short run, could give rise to increased vulnerability and fragility over a period of time. Following the onset of the COVID-19 pandemic, we injected liquidity, but almost every measure of liquidity injection was for a limited period and was targeted. By doing so, we avoided the pitfall of a liquidity trap. Further, our lending standards were not diluted in terms of our counterparties (banks) and collateral requirements for on-lending to stressed entities or sectors.

On the regulatory side also, our actions were measured. We allowed lenders to offer moratorium on loan repayments and interest payments. We put in place loan resolution frameworks for the COVID-19 related stressed assets thereafter. These loan resolution frameworks were not open ended but subject to achievement of certain financial and operational parameters. The idea was to avoid the phenomenon of ‘moral hazard’ and other pitfalls typically associated with open ended restructuring of loans.

We are acutely aware that a healthy and efficient banking and financial system is the primary stabilizing force against various shocks. Mindful of this, we have carried out a series of reforms in our regulatory and supervisory architecture. We have come out with certain governance guidelines for banks and introduced a scale-based regulation for non-bank financial companies (NBFCs), based on the size and complexity of their businesses. The process of supervision of banks, NBFCs, and other financial entities has also been substantially strengthened with the focus being on early detection and pre-emptive correction, rather than reacting to the symptoms of weaknesses.

Thanks to a confluence of factors, including to a large extent, the steps taken by the Reserve Bank, the Indian economy has emerged as an epitome of stability and opportunity. We have not only kept our house in order against large and overlapping global shocks but also improved our macroeconomic fundamentals and buffers. While growth remains on track, inflation is on a path of moderation, though it is still above the target.

The balance sheets of banks and corporates are the healthiest in a long time and with the public investment push by the Government, they create favorable conditions for a sustained revival in investment. Consumer confidence, as evident from our surveys, is on a rising trajectory since the pandemic lows. Our external sector inspires confidence as we are reaping export opportunities, in the services sector; our current account deficit remains eminently manageable; and we have bolstered our forex reserves to deal with potential eventualities.

Today, India has become the new engine of global growth with its young demography, improving physical and digital infrastructure, and above all, an enabling policy environment. In this context, Japan and India continue to be the natural partners. We share deep historical ties. The teachings of Gautama Buddha have inspired our shared ethos and cultures. We look up to the Japanese “Economic Miracle” as a learning opportunity as we prepare the ground to uplift India’s growth trajectory.

Japan has played a critical role in infrastructure building in India through several public and private sector partnerships. There are many collaboration opportunities in frontier technologies such as space technology, artificial intelligence, quantum computing, rare-earths extraction, semiconductors and resilient supply chains, and other areas. Our partnership could also be potentially strengthened in the sphere of human resources. I am sure the future offers limitless possibilities to deepen our engagements for the benefit of our people and the entire world.

It would be worthwhile here to look a little deeper into India’s growth drivers, its experience of managing inflation since the pandemic, and the emerging opportunities and challenges, especially in the Fintech space.

Growth Drivers

Policy focus on strengthening macroeconomic fundamentals and continued structural reforms have made India distinct in terms of growth outcomes. This was reflected in the rebound in GDP growth after the pandemic from a contraction of 5.8 percent in 2020-21 (pandemic year) to a growth of 9.1 percent in 2021-22 and 7.2 percent in 2022-23. The GDP grew by 7.8 percent in the first quarter of 2023-24, and the available high frequency indicators suggest a continuation of this momentum. For the full year 2023-24, real GDP growth is projected at 6.5 percent by the Reserve Bank.

The innate resilience of the Indian economy could be attributed to its well-diversified economic structure. Although India has made rapid strides in external openness through trade and financial channels and gained competitiveness, its core dependence for growth continues to be its domestic demand which also provides a cushion against external shocks.

Among the constituents of aggregate demand, private consumption accounts for over half of GDP (around 57.0 percent average share during 2011-12 to 2022-23), followed by fixed investment and government consumption. During the post-pandemic recovery, private consumption contributed an average of 66.0 percent to GDP growth during 2021-22 and 2022-23.3 At the same time, structural reforms related to banking, digitalization, taxation, manufacturing, etc., have laid the foundation for a strong and sustainable growth over the medium and long term.

On the supply side, while the agricultural and the industrial sectors are maintaining their underlying momentum with a renewed focus on manufacturing, a major part of India’s growth is coming from the services sector which again largely depends on domestic demand. With crucial transformations underway, India’s services sector is expected to lift its future trajectory of growth with a major impetus coming from rapid digitalization of the economy, which could be a game-changer for economic development.

The external demand for India’s services is also increasingly gaining significance with services exports growing rapidly on the back of rising competitiveness in niche areas. India’s services exports are diversifying from information technology (IT) related services to other professional services such as business development, research and development, professional management, accountancy, and legal services. Domestic services are also undergoing a steady shift from low-skill consumer-oriented services towards more technology-enabled business services.

The newly emerging start-ups are largely concentrated in the services sector. Capitalizing on India’s impressive public digital infrastructure, many of these start-ups function as service providers for other businesses by offering services ranging from facilitating digitization and improving access to credit.

Managing Inflation

As in the case of growth, there are some nuances in India’s experience in managing inflation vis-à-vis other countries. The nature of inflation shocks throughout much of 2020 and 2021 in India was largely supply-side shocks, coming from COVID-19 lockdowns and adverse weather events. As lockdowns were withdrawn and the impact of weather disturbances waned, forces of inflation correction began to operate. The monetary and fiscal support provided during the pandemic were measured and targeted. Consequently, demand-led inflation pressures in India were much lower compared to several other economies.

The monetary policy committee (MPC) of the Reserve Bank was, therefore, able to look through the intermittent higher inflation prints to support economic growth during and in the aftermath of the COVID-19 pandemic. The MPC took the considered view that policy tightening in such a scenario would only accentuate the growth slowdown and impart higher volatility, without being able to properly address the first-round effects of temporary supply-side shocks. This approach was in consonance with the flexibility embedded in our flexible inflation targeting framework wherein the primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth.

In early 2022, with the waning of COVID-19 shocks on inflation, a gradual easing of supply bottlenecks, and a forecast of a normal monsoon, inflation was expected to witness a significant moderation to the target rate of 4 percent by Q3:2022-23. These expectations were completely overturned by the war in Ukraine. Initially, the shocks came from the spike in global fuel and food prices, which got further accentuated by local adverse weather events. These shocks got transmitted to the retail prices of goods and services, as domestic economic recovery and rising demand enabled pass-through of the large pent-up input costs. This also imparted stickiness to underlying core inflation. The result was a generalized inflationary impulse.

In the period that followed the Ukraine war in 2022, what stood out in India was the coordinated monetary and fiscal policy response to tame the inflationary pressures. The MPC quickly changed gears by prioritizing inflation over growth, while changing its stance from being accommodative to withdrawing accommodation in April 2022. The MPC then went on to increase the policy repo rate by 250 bps cumulatively between May 2022 and February 2023, to keep inflation expectations anchored, break the core inflation persistence, and contain second-round effects.

Looking back, several aspects of our conduct of policy helped in taking decisive and timely action during the heightened inflation pressures seen in 2022-23. First, prudence was the cornerstone of the monetary policy response to the COVID-19 shock, with most of the extraordinary liquidity injection measures being targeted with pre-set end dates. This ensured an orderly unwinding of the monetary stimulus as growth recovered. Second, the Government also adhered to fiscal prudence, with an actual fiscal deficit for 2022-23 kept in line with the Budget Estimates. Third, complementing the monetary policy measures was a series of proactive and targeted supply-side measures by the Government. All these factors put together, proved to be critical in moderating the price pressures.

As things stand today, the MPC in its October 2023 meeting has projected CPI inflation at 5.4 percent for 2023-24, a moderation from 6.7 percent in 2022-23. Headline inflation, however, remains vulnerable to recurring and overlapping food price shocks. The core inflation has also moderated by 170 basis points since its recent peak in January 2023. In these circumstances, monetary policy remains watchful and actively disinflationary to progressively align inflation to the target, while supporting growth.

Concluding Observations

It is a matter of satisfaction that the Indian economy has sailed through the turbulent waters smoothly during the recent years. Driven by its inherent dynamism and supported by a prudent policy mix, growth is getting a stronger foothold while inflation is also coming under control. Our economic performance also owes a lot to the very calibrated, focused and targeted monetary and fiscal responses since the pandemic.

I must add that in the current uncertain environment, it is best to avoid any sense of complacency. We remain agile and continue to fortify our macroeconomic fundamentals and buffers. Today, the confidence and trust in India’s prospects are at an all-time high. To seize the moment, India looks at Japan as a close partner to usher in a new era of growth and prosperity, for both our countries. We will be celebrating the festival of lights, Deepavali, in a few days in India. With Japan as our close partner, I am sure the land of the rising sun will further light up our spirits to take our economies and the well-being of our people to greater heights.

RBI notes:

·         India is endowed with a great demographic dividend as 68 percent of the total population estimated at 1.429 billion in the latest World Population Report 2023 (United Nations Population Fund) belongs to 15-64 years

·         Some of the flagship infrastructure projects completed/underway through Japanese collaboration include the well-known Delhi Metro; the Western Dedicated Freight Corridor (WDFC) and the Delhi Mumbai Industrial Corridor (DMIC); and the Mumbai–Ahmedabad High-Speed Rail Corridor (MAHSR), among others

·         In other comparable large Emerging Markets (EMs), the contribution of private consumption to growth was lower, e.g. 60.0 percent in China, 40.0 percent in Brazil, and 31.0 percent in Indonesia during 2021

·         Government action to tame inflation included restrictions on wheat, rice, and sugar exports; cut in excise duties for petrol and diesel; exempting imports of pulses from import duties; release of pulses at a discount to states and union territories; stock limits for wheat and pulses; reduction in import duties on various edible oils and additional procurement and discounted sale of key vegetables among others

Overall, RBI blamed India’s sticky core inflation in 2021-22 and H1CY23 AROUND +6.00% due to supply chain disruptions, elevated demand due to COVID stimulus, coupled with Russia-Ukraine/NATO war related geopolitical tensions and economic sanctions, and subsequent higher commodity prices (fuel & food)-Putinflation. Also, some adverse weather-related events in India are responsible for temporary spikes in some food/vegetable prices. But India’s core inflation is now on the downward path due to improvements in the supply chain (post-COVID), active intervention by the government to improve supply bottlenecks and higher borrowing costs, resulting in lower demand and lower inflation.

Despite upbeat economic growth, India’s GDP/Capita is the lowest in the G20 universe. Also, India has significantly high unemployment/underemployment and thus India needs to grow at least by +8.0% (if not 10% /double digit) in the coming days, keeping core inflation around +4.0%. India needs huge capex for transportation infra, especially high-speed railway and social infra (quality hospitals, schools & colleges). Thus, RBI has to keep borrowing cost/GSEC bond yield lower to fund government borrowings at lower interest levels. India now pays almost 45% of tax revenue as interest on public debt against 9% of the U.S. and 5% of China. This is a redline for India and one of the primary reasons behind just above junk rating.

Market wrap:

On Friday, USDINR surged to a new lifetime high of around 83.50 on a higher US dollar index and hopes of an early RBI cut (by Feb’24). USDINR may scale 85 levels in the coming days on policy divergence between RBI and Fed ahead of general elections. Also, USDINR is getting a boost on suspected black (offshore) money round-tripping to fund unofficial electoral expenses of major Indian political parties. Historically, USDINR always gets a boost ahead of any general or even big state election.

Overall, for the last two weeks, Nifty was boosted by ICICI Bank, L&T, RIL, HDFC Bank, Axis Bank, Sun Pharma, SBIN, Kotak Bank, Ultratech Cement, Bharti Airtel, Asian Paints, Titan, BPCL, Apollo Hospitals, Power Grid, ONGC, Indusind Bank and Cipla, while dragged by INFY, Maruti, TCS, Bajaj Finance, Adani Enterprise and HCL Tech. For the last week, Dalal Street was boosted by pharma, realty, metal, energy, infra, automobiles, private banks & financials, FMCG, and techs, while dragged by selected PSU Banks and media stocks.

Technical trading levels: Nifty Future

Whatever may be the narrative, technically Nifty Future (19536) now has to sustain over 19650 for a further rally to 19725/19775 and further to 19885/20055-20200/20300 levels in the coming days; otherwise sustaining below 19600, Nifty Future may again fall to 19380/19300-19090/18830-18625/18490-18275/18075 in the coming days.

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