India’s benchmark stock index made a 4-month low of around 17255.20 on 28th February. Overall Nifty lost almost -8% since Dec’22 primarily due to global macro headwinds, higher borrowing costs, and sticky core inflation (both globally/U.S. and locally). Further Indian market was also affected by the Adani saga and related banks & financials, having significantly high exposure in various Adani groups.
But Nifty also rebounded on hopes & hypes of a lower Fed/RBI terminal rate, India’s upbeat economic growths (despite higher borrowing costs), upbeat PMI, a mixed earnings report card for Q3FY24, and Adani boost. Adani group of stocks included in Nifty (Adani Enterprise, Adani Ports) rebounded on favorable SC orders and renewed trust by some FPIs. The Indian SC has formed a committee to look into the veracity of various allegations by Hindenburg against the Adani group, while the latter sells a partial promoter’s stake now worth around Rs.154.45B ($1.87B) to U.S. firm GQG Partners. This shows that the stressed conglomerate Adani group may still raise capital, which in turn boosted banks & financials (such as SBI (NS:), ICICI, Axis, and IndusInd Bank (NS:)) having exposure to the group. Subsequently, on Friday (3rd March), Nifty jumped +1.57% and closed around 17594.35 before making a high of 17644.70.
On 8th February, as highly expected, India’s Central Bank RBI hiked all effective policy rates by +0.25% as expected by the market, which is a step down from earlier +0.35% and +0.50% (in line with Fed’s rate action). The RBI repo rate is now at +6.50%, at levels of Jan’19 after the 6th consecutive rate hike since May’22, totaling +250 bps. RBI also raised the effective reverse repo rate (SDF-Standing Deposit Facility), MSF (Marginal Standing Facility), and Bank rate by +25 bps each to +6.25%, +6.75%, and +6.75% respectively.
RBI lowered its headline inflation (CPI) forecast for FY23 to 6.5% from 6.7% and revised India’s real GDP growth to 7% from 6.8%. For the next FY24, RBI projected headline CPI to ease further to 5.3% with an economic (real GDP) growth rate of 6.4%. Some market participants were also expecting a clear message of pause by RBI after the December hike. But RBI didn’t convey any message of pivot (pause) and telegraphed another smaller/calibrated hike of +25 bps in the coming months by keeping an owlish stance on the evolving inflation dynamics.
RBI is quite worried about sticky core inflation around +6.00%, at RBI’s upper tolerance band, while upbeat about economic growth amid domestic resilience despite global macro headwinds and subdued merchandise export. Thus there is no concern about a hard landing and RBI may continue to follow Fed and hike rates to bring down core inflation towards 4% targets.
The U.S. economy is now slowing down, but price pressure/core inflation and the labor market are still substantially hot. And the Fed is now clearly preparing the market in a calibrated way for a 5.50% terminal rate by June’23 and then a pause to assess. Fed will ensure price stability along with financial/Wall Street stability avoiding a hard landing. Fed will keenly watch the core inflation trajectory for Q1CY23 and then make a fresh SEP on 16th March for the projected terminal rate for 2023 (after reaching +5.00% repo rates).
As per Taylor’s rule, for the US: (Pointed out by Fed’s Bullard several times)
Recommended policy rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(5.5-2.00) =0+2+3.5=5.5%
Here for U.S. /Fed
A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation=5.5% (average of core PCE and CPI)
The market has now almost fully discounted Fed repo terminal rate +5.50% by June’23; i.e. consecutive further rate hikes +25 bps each in March, May, and June. The Fed may go for a pause after June’23 for the next 6 months to assess the impact of cumulative tightening on the overall economy, labor market, consumer demand, and inflation. Fed may hold rates/FFR around +5.50% till at least June’24 before seriously beginning any debate for rate cuts (ahead of Nov’24 U.S. Presidential election), if core inflation indeed goes down towards +2.00% targets or even fall below +3.00% with a definitive dis-inflationary trend.
India’s RBI may also hike +0.25% on 6th April and further +0.25% in June for a terminal rate of 7.00% against the Fed’s 5.50%. India’s core CPI continues to be sticky around +6.00% and thus RBI wants to ensure a real positive rate, by at least +100 bps (restrictive levels) wrt at least average core inflation.
Thus RBI will continue to tighten to keep interest rate/bond yield differential and also under control, which will also control imported inflation and manage overall price stability. RBI has to tighten in a calibrated way to bring inflation down by curtailing demand; i.e. slowing down the economy to some extent without causing an all-out recession for a safe and soft landing.
As per Taylor’s rule, for India:
Recommended policy rate (I) = A+B+(C+D)*(E-B) =0.50+4+ (1.5+0)*(6-4) =0+4+1.5*2=0.50+4+3=7.50%
Here for RBI/India:
A=desired real interest rate=0.50; B= inflation target =4; C= permissible factor from deviation of inflation target=1.5 (6/4); D= permissible factor from deviation of output target from potential=0; E= average core CPI=6
If Fed continues to hike even after June’23 to +6.00% by Sep’23 (in case U.S. core inflation surges more), then RBI also has to hike (under still elevated/sticky core inflation). Thus RBI may like to keep the repo rate at 7.00% to 7.50% in CY23, depending upon the Fed rate action; as USD is the reserve/global currency, every major Central Bank has to follow Fed action to maintain bond yield/currency and policy differential (whatever may be the narrative) to control imported inflation.
India also pays almost 45% of its tax revenue as interest on public debt and over 40% on salary & pensions for government employees (including militaries/other agencies). Although a huge pool of government employees is also providing robust consumer spending (discretionary) amid real wage growths, job stability, and family pension security for a lifetime, India needs to control its sticky core inflation for relatively lower bond yield and lower borrowing costs for overall lower cost of living for the masses. Also, India needs to improve its innovation and productivity, which is the ultimate.
But Indian consumer spending is also resilient despite the higher cost of living because almost 30% of the Indian middle-class population, equivalent to the entire U.S. population has stable jobs/income (government and reputed corporate employees), and has adequate real wage growths regularly. Many Indian super riches are now growing rapidly, thanks to the vibrant stock & real estate market and digital ecosystem.
Also, despite DEMO in 2016, the flow of black money in the Indian economy is still robust due to rampant corruption at almost all levels, especially in various infra projects (cut money) and even certain state levels of government employment. Thus, despite higher inflation, higher borrowing costs, and higher cost of living, the Indian consumer spending story is still robust, causing sticky core inflation. This coupled with targeted government fiscal stimulus (deficit spending, huge infra stimulus, and other CAPEX) is ensuring a robust Indian growth story, resulting in India as a ‘bright spot’ in the present global turbulence.
RBI, as a debt manager of the government, will have to also ensure lower borrowing costs by controlling bond yields directly/indirectly. Thus considering all the pros & cons, RBI may also pause after reaching a terminal repo rate of 7.00-7.50% by June-September’23 and may go for rate cut moves from early 2024, just ahead of a general election in India.
Fed may also go for rate cuts ahead of the Nov’24 U.S. Presidential election with the hope that U.S. core inflation will come down towards the 2% target. But as RBI may be in a position to cut rates earlier than Fed, USDINR may scale 85-90 levels by early 2024; traditionally USDINR always appreciates significantly ahead of any Indian general election to finance unofficial huge election spending of various political parties (Indian black money round-tripping).
On 28th February, Indian government flash data (MOSPI) shows India’s real GDP for Q3FY23 was around Rs.40.19T vs 38.81T sequentially (+3.56%) and 38.51T yearly (+4.36%); i.e. the Indian economy has grown around +3.5% sequentially in Q3FY24, the same rate at Q2FY24, while yearly growth was around +4.4% against +6.3% in the previous quarter, and below market consensus +4.6%. The MOSPI has also projected FY23 real GDP at around Rs.159.71T against the FY22 preliminary estimate of Rs.149.26T; i.e. a growth of around +7.0%. This should translate the Q4FY23 real GDP to around Rs.43.23T; i.e. a sequential growth of around +7.5% and yearly growth of around +5.1%. As per the long-term sustainable trend, Indian real GDP may grow around 1.50-2.00% on an average sequentially; i.e. an annualized rate of around 6.00-8.00% (y/y) under normal conditions.
India is a bright spot in a gloomy world and a favorite among EMs (except China) for global investment due to political and policy stability. Thus Indian stock market enjoys a scarcity premium and higher PE compared to its peers or even AEs.
BRICS (Brazil, Russia, India, China, and South Africa) were the investment theme in the early 2000s when EM investors hoped to capitalize on their economic growth and population expectations, as well as their sources of raw materials/commodities. Except for China, India now has the most political/policy and macro stability. Also growing political chaos in big Western democracies is causing policy paralysis and working advantageous for not only India but also China. India may become the world’s 3rd largest economy by 2030 if policymakers can focus more on targeted fiscal stimulus/reform, capex, especially railway, and EV to improve productivity. India has to also improve its innovation to compete with South
Asian exporters and also some AEs. India is now a major beneficiary of political/policy stability and the appeal of 5D (development, demand, demography, deregulation, and digitalization
But at the same time, India needs to control its huge population to improve GDP/per capita and growing unemployment (8.30% in Dec’22; 7.1% in Jan’23; pre-COVID levels of 7.8%). India is now around $3.4T economy, 5th largest in the world (nominal GDP at current prices) along with a population of around 1.42B; i.e. GDP/Capita is only around $2395, at 20th position in G20. Even with a projected $5T economy along with a 1.50B population by 2030, India’s GDP/Capita will be only around $3333 and should remain at the 20th position in G20; China’s present GDP/Capita is now around $11500 compared to the U.S. around $62000, Singapore’s $66300, Indonesia $3950, South Africa $6000, Brazil $8700, Mexico $9600 and Russia $10000.
There is a need for political courage/wish for a big-bang reform like India’s population control. Although various BJP-ruled states are talking about it directly/indirectly like the ban of any government job or subsidy for any family above 2 children, the Indian Federal government led by PM Modi should make it a universal policy, without worrying about certain vote banks as now BJP/Modi has virtually no credible political opponent/opposition at the national level. India is the biggest stable democracy in SE Asia, having huge manpower (low-cost labor) to compete with China. But India also needs more deregulation and a lower/simple direct/indirect tax structure including tariffs to compete with China, Vietnam, and other SE Asian exporters.
The latest data from S&P Global (NYSE:) shows India’s Composite PMI was up to 59.0 in February from 57.5 sequentially. The latest reading pointed to the 19th straight month of growth in private sector activity. Services activity grew at a stronger rate than the manufacturing sector, but grow stronger in both cases. New orders expanded, as has been the case in 11 years, with services firms also registering a faster upturn in new business than their manufacturing counterparts. On prices, input cost inflation eased to a 29-month low, while prices charged went up the least in 12 months.
The current sequential run rate of Nifty EPS (consolidated) growths is around 3.75%; i.e. annualized +15.00%. As per the current sequential run rate, FY23 EPS may come to around 931, and assuming +20% CAGR for FY: 24-26 (in line with expected nominal/basic GDP growths); the consolidated Nifty EPS may print around 1070-1284-1541. And assuming a median/average PE of 20, the average fair value of Nifty may be around 18600-21400-25700-30825 for FY: 23-26. As the financial/stock market generally acts on expectations or discounts 1Y projected/forward EPS in advance, Nifty may scale around 18600-21400-25700-30825 by FY: 23-26.
In Q4FY23/FY24, Nifty earnings may be boosted by higher commodity prices amid China reopening. Although a higher interest rate regime (bond yield curve steepening) is positive for banks & financials and negative for leveraged non-financials to some extent, there may be also elevated retail NPA as most of the loans including mortgages are on a floating interest rate basis. And most of the big Indian corporates are now largely deleveraged or have sufficient positive cash flow to service loans. In any way, both Fed and RBI may indicate rate cuts in early 2024 if there are signs that inflation is steadily easing towards targets, Dalal Street and Wall Street will also flare up ahead of the respective general election on the expectations of lower borrowing costs.
Bottom line: Nifty Future: 17661 as of 03/03/23-EOD
Looking ahead, whatever may be the narrative, technically Nifty Future now has to sustain over 17800 for a further rally towards 17900/950-18075/300* and a further 18350/450-555/650 in the coming days; otherwise sustaining below 17750, Nifty Future may again fall towards 17600/500-450/350* and further 17240/200-16950/650 levels in the coming days.