OUTLOOK INDIA 2022
US equity indices get into lower high mode (moving away from 2021 close & January 2022 high) post strong signals from Jackson Hole meeting that inflation control is the priority of FED and that efforts would be made to achieve positive real interest rate by either pushing inflation below 4% or raising Fund rate over 4%. Given that soft landing of inflation below 4% by mid 2023 is not a high probability hope, stakeholders have now started aligning to worst case of fears where Fund rate stay elevated & sticky at upper half of 2-5% against previous expectation of softening at 1-3.5% by mid 2023! While FED is under pressure to get inflation down to 2-4% by mid 2023 guiding Fund rate over 4%, there’s no clue on managing negative outlook on growth and sub-optimal capacity expansion & employment, keeping alive fears between risk of stagnation and worry of recession. So, when macroeconomic dynamics are in rising interest rate regime against negative growth, there’s no game for being overweight on equity risk while investors prefer short duration debt/fixed income investments to avoid capital erosion from equity investments!
S&P outlook for end of 2022 is not optimistic when significantly below 2021 close 4766 and 2022 high 4817 while in trend down mode at 3650-4350 (keeping most play around 4000 ahead of rate hike event) since guidance from Jackson Hole pulling mid June 2022 low 3636 into the radar. It’s possible that 2022 goes behind delivering YoY negative return of 15-20% giving away most of the gains of 2020-2021 with close not far away from 2019 close 3230 (but above 3636) for around 12% gains for 3-year cumulative period of 2020-2022! While US equities have lost heavily in 2022, it’s no better on long-duration debt capital market with 10Y yield up at 3.15-3.50% against 2021 close of 1.5% and 2019 close of 1.9%. It’s no better on shorter duration 2Y curve with lift from 1.57-0.73 (2019-2021 close) to 3.5% by end 2022!
What’s the impact from infusion of extraordinary fiscal stimulus and ultra-dovish monetary policy?
On an end to end basis through 2020-2022, investors have nothing much to gain from equities while incurring capital erosion on debt investments. And it’s worse on macroeconomic factors – high inflation, growth contraction, bloated FED balance sheet and low consumer confidence on the global economy. In the meantime USD Index moved up from 96-95.60 (flat in 2020-2021) to 110-111.50 up by 15% in 2020-2022 aligned to higher FED Fund rate and covering for widening interest rate differential with major currencies. When inflation is on the rise and economy in downturn, Gold should have triggered safe haven bull run, but trending down from 1828-2070 (2021 close – 2022 high) finding support at strategic base $1685-1720 with positive return over 2019 close $1517, up by 13% for 2020-2022.All combined, overdose of fiscal & monetary stimulus from US & developed economies caused severe damage on inflation without being catalyst to growth & employment while cost-benefit of economic-financial impact doesn’t add up to creat value for investors. While it ends up as zero-sum game for 2020-2022, what next in 2023-2024 is nightmare, building uncertainties around end of rate hike cycle (where & when?) and bad choice to choose between stagflation & recession. It has gone to an extent that set up of recession to help softening of inflation is seen to be the best expectation to end rate hike cycle in Q1/2023 for shift into rate cut cycle in Q4/2023 for better 2024, both for global economy & financial markets.
What’s is India context in 2020-2022 from impact of external sector and could it be better in 2023-2024?
India equities have outperformed most of rest of the world in 2022 and 2020-2021 cutting across pandemic phase & turn to reversal of accommodation. Nifty up from 12168 (2019 close) by over 40% for 2020-2022 and 2% to 6% for 2022 over 17350 (2021 close) with assumption of 2022 close at 17650-18350. While Bank Nifty lagged behind in 2020-2022 (nursing NBFC-NPAs linked wounds) with around 20% gains over 2019 close 32161, and around 13-17% for 2022 against 2021 close 35481 assuming 2022 close at 40150-41650. It’s good that investors ended up getting above par returns (over 10% annualised) from equities despite going through tough phase of pandemic in 2020-2021 and monetary tighten cycle in 2022!
On the debt capital market, it’s back to status-quo, current Repo rate of 5.40% same as that of 2019 close rising from 4% (effective operating rate of Reverse Repo rate at 3.35%) since May 2022, start of rate hike cycle. It’s been a roller coaster volatility on 10Y yield during this phase down from 7.5% to 5.75% in 2020-2021 and up at 7.65% in 2022 preparing for year end close at 7.15-7.25%. It’s kind of zero-sum game for passive & long-only investors through 2020-2022 while making highly profitable on duration play.
USD/INR play during 2020-2021 is normal moving up from 71.35 to 74.35 at annualised 2% depreciation despite heavy dose FPI inflows from excessive offshore liquidity. The change of monetary policy dynamics in the US in 2022 pushed INR down by around 7.5% while providing comfort of sub 4% annualised weakness for 2020-2022 covering for India-US interest differential. Having lost against USD (by over 7.5% in 2022), INR has gained against EUR by 7% (84.65 to 79), by 9% against GBP (101 to 92) and 15% against JPY (0.65 to 0.55). The outlook of USD/INR for rest of 2022 is not beyond 78.50-81.50 (high probability close at 79.35-80.65 while retaining appreciation phase against major currencies. It’s win-win set up for all stakeholders with good balance between depreciation & time value on USD, while those carrying liabilities on major currencies have stand to make windfall gains and worse for companies that have export receivables invoiced on EUR/GBP/JPY.
What’s the India take-away from 2020-2022 and the outlook for rest of 2022?
When global economy is in cross roads between stagflation and recession, offshore investors have sailed through safely – getting best out of 2020-2021 and losing out on 2021-2022, while it turned out to be different for India – super gains in 2020-2021 and above par returns in 2022. The rest of 2022 outlook covers 125-150 bps rate hike by FED lifting Fund rate to 3.50-4.0% while RBI is expected to hike by 35-60 bps lifting Repo rate to 5.75-6.0% during the 2 meetings to go before end of 2022! The said outlook is adequately covered with US 2-10Y yield curve at 3.50-3.35% and India 1-10Y yield curve at 6.35-7.35% (allowing for squeeze at 6.65-7.50% seen as worst case scenario).
Where from India derives the game changing advantage and risk factors?
India optimism leading to outperformance in Q3/2022 is from (a) shift in Brent Crude outlook from $100-135 to $65-100 (b) USD strength close to the peak with USD Index set to lose sustainability beyond 108.50-111.50 (c) less worry on India achieving positive real interest rate without pushing Repo rate beyond 5.75-6.0% (d) growth-inflation staying positive without building risk of stagflation or recession with FY23 GDP growth outlook above 7% and inflation below 7% while woes around twin-deficits set to get better in FY24.
Risk factors to India optimism are largely from the external sector (a) FED pushing Fund rate beyond 4% in 2023 if inflation remain sticky above 6-7%. (b) combination of rate hike and Quantitative tightening would drastically reduce quantum of FPI inflows (c) recession in the West would be negative for India exports & investments adding pressure on rate markets (d) geopolitical risks & resultant volatility on Brent Crude.