Year 2022: War, Record high inflation, Policy Pivot, Recession fears
Year 2022 was marked with new kind of shock in form of rise in geopolitical risk, impact on supply chain with wider implication on global inflation and thereby on policy making. Global inflation rose sharply to record high levels and global central bankers had to resort to unconventional policy of aggressive and front-loading of rate hike cycle.
Commodity prices (including food) were highly volatile, so were financial markets (from equity, bond to currency). Economic growth forecast had to revise down continuously and there has been looming fear of recession/hard landing in near future. Opening up of China has raised new hopes for growth and increased cases of covid raised the fear of pandemic spreading again.
Stepping into new year, there are growing concerns about global recession amid gradual decline in inflation, uncertainty related to geopolitical risks (extended wars) with central bankers across globe keeping policy rate high for longer time.
Headline Inflation eased to 5.88% y/y (Previous: 6.77%y/y). This was lower than seasonality and market expectations (6.4%). Latest print is lowest in 11 months and below 6% mark (RBI’s upper band) since Dec 2021. Favourable base effect, disinflation in food and muted housing prices helped in bringing down headline print. Sequentially headline prices decline (first time since Jan 2022) driven mainly by food prices, lower than seasonal uptick in housing prices and moderate pickup in services and fuel prices. Market core rose a bit to 6.04% (Previous: 5.99%) driven mainly by clothing & footwear and higher momentum in household goods & services & health. Average YTD FY23 inflation print stood elevated at 6.95%y/y (FY22: 5.51% y/y).
The current RBI’s policy hike cycle is characterised by aggressive front-loading strategy (as against baby steps policy generally followed during pre-pandemic times). With most of the rate hike cycle behind us, RBI, in Dec’s policy, decided to moderate pace of rate hike to 35 bps (from average ~40-50 bps per meeting in current cycle). Key policy rate now stands at 6.25% (Feb 2019 lvls) and cumulative repo rate hike till date is 225 bps. RBI’s statement indicated that further rate hike(s) is (are) still on table and depends on evolving inflation trajectory.
Apr-Nov 2022 Tax collections continued to remain robust, while expenditure growth has accelerated from September onwards - driven by both revenue and capex. As a result, despite recent pick-up in expenditure, fiscal deficit remained ~59% of Budget Estimate(BE) (pre-pandemic trend: 90%). Robust December GST data (third highest in FY) & strong December advance collections indicates that overall tax collections till date continues to remain robust.
Trade deficit has worsened since start of the fiscal year, driven by sharp moderation in exports (complete ban, export duties, export quota) and jump in imports due to strong domestic demand & high acceleration in crude prices. Although recent months have seen slowdown in imports (aided by lower commodity prices), trade deficit continued to remain elevated at ~US$26-27 bn (Jul through Oct) on continued deceleration in exports. November print provides some respite with monthly trade deficit at US$24 bn -driven by decline in imports (mainly oil), while exports continued to remain sluggish.
2Q FY23 CAD print came high at 4.4% of GDP (1Q FY23: 2.8%; 2Q FY22: 1.3%) - driven by trade deficit. Only green shoots were, robust services growth and buoyant remittances. With record high trade deficit and muted capital flows (negative banking capital, muted FDI flows), balance of payment (BoP) was in deficit at US$30 bn. With Apr-Nov trade print available and based on emerging trends, FY23 CAD print is expected to be in range of 3.4%-3.6% of GDP (much above RBI’s comfort levels of 2.5%).
After witnessing marginal outflows in Sep-Oct’22 , FPI saw a net inflow in November (US4 bn) and December (US$1 bn). While RBI has been intervening regularly in forex markets, impact of adverse external imbalances was clearly evident on exchange rate movement over last couple of months. After continuous depreciating since start of calendar year, Rupee appreciated marginally in Nov, only depreciating a bit in December despite depreciation in dollar index. Average Rupee was ~82.46 during the month (Nov: 81.81, Oct: 82.34, Sep: 80.23, Avg July-Aug: 79.55-79.59, Jun: 78.07, May: 77.27, Mar-Apr: 76.09- 76.26, Jan-Feb: 74.44 -95). YTD CY2022 rupee depreciated ~ 11.4% against dollar.
Yield Levels & Spreads:
G-sec market started the month on positive note driven mainly by correction in oil prices, rally in US treasury and depreciation of dollar index. It rose post RBI policy (on expectation that rate hike is still on the table), US rate hike and on opening up of China from trading in range of 7.30-7.48% in Nov, 10-year G-sec started the month at 7.21%, moved up to 7.3% post RBI policy, eased a bit on inflation print to 7.22 lvls by mid-month, again rose to 7.3 lvls post Fed policy and stayed around those levels till end of the month to closed the month at 7.33 levels (Nov end : 7.28%, Oct: 7.45%, Sep: 7.39%, Aug:7.18%, July:7.32%, June:7.45%, May: 7.42%, Apr: 7.12%, Mar: 6.84%).
10 year Term premia (10 yr over 365 days) eased a bit to average ~42 bps during the month (Nov: 46 bps, Oct: 58 bps, Sep: 77 bps, Aug: 104 bps, Jul: 120 bps, Jun: 133 bps, May: 166 bps, Nov 2021- Apr 2022: 222- 238 bps).
While 10 yr SDL yields tracked 10-year G-sec yields, the movement was more range-bound. It closed the month at 7.55% (Nov: 7.58%, Oct: 7.76%, Aug-Sep: 7.52-7.57%, May through Jul :7.70-7.78%, Apr: 7.27%, Mar: 7.18%). Nov SDL primary supply stood at Rs.53,462 cr (Nov: 56,899 cr, Oct 22: 70, 450 cr, May-Sep 22 monthly average ~50,000 cr, Apr 2022: 10,000 cr). The average spread between 10 yr SDL over G-sec eased to 26 bps during the month (Nov: 33 bps, Oct: 29 bps, Sep: 28 bps, Aug: 35 bps, May-Jul: 29-33 bps, Apr: 21 bps).
AAA bonds yield were range-bound for most part of the month, only to increase in the last week of the month. 10 yr AAA PSU were range-bound ~7.6 lvls for most part of the month, only to close the month at 7.65% (Nov end: 7.58%, Oct end: 7.76%, Sep end: 7.76%, Aug end: 7.51%, Jul end: 7.7%, Jun end: 7.89%, May end: 7.77%, Apr end: 7.35%).
Global inflation eased further in November, driven by decline in advanced economies and emerging economies. November print indicated better than expected decline in inflation. Global food prices continued to decline, with IMF’s Food and Agriculture Organization (FAO) food index now flattish vis-à-vis record 34%y/y in March 2022. After sharply rising since start of year, the global inflation probably peaked in Sep-Oct and is finally showing signs of easing down. That said, with inflation expected to remain above global central bankers’ comfort level in coming months.
Persistently strong inflation has forced central banks globally to front-load and exercise larger hikes and withdraw surplus liquidity at faster pace. From Dec, central banks across globe from US Fed, ECB to RBI have opted to go slow on the rate hike size (i.e. to go slow on policy tightening) – to assess the impact of previous rate hike given the time lag required for monetary transmission on real economy. With most of rate hikes in current cycle already done, US Fed policy statement and post policy meeting clearly signalled the speed of future rate increase will be dependent on evolving data.
After sharp rise in yields in Sep-Oct on hawkish pivot, US treasury yields eased from their record high levels in November. The easing bias continued into December first half driven by correction in oil prices and better than expected monthly inflation print, only to rise towards the end of month on opening up of China. The US 10 Yr Treasury bond yield started the month on positive note at 3.53%, eased to 3.44% by mid- month, only to increase towards the end of the month and close the month higher at 3.83% (Nov end: 3.68%, Oct end: 4.10%, Sep end: 3.83%, Aug end: 3.15, July end: 2.67%, June end: 2.98%, May end: 2.85%, Apr end: 2.89%, Mar end: 2.32%, Feb end: 1.83%, Jan 2022 end: 1.79%).
In Dec’22, Dollar Index depreciated further by 3.3% m/m (Nov: -ve 3.5%m/m). It closed the month at 103.52 (Nov end: 108.05, Oct end: 111.53, Sept end: 112.11) YTD Dollar index has rose by ~8%.
- Nov’22 inflation print was lower than expected driven down by lower momentum in food & housing prices. Going forward, while Dec’s print is likely to be impacted by adverse base effect, the monthly prints are likely to decline further in 4Q aided by favourable base effect, seasonality and expectations of declining demand pressure amid growth concerns.
- Given the RBI’s concerns about inflation, future rate hikes are still on table. Henceforth rate action will be data-dependent. (Reason: Persistent and sticky nature of core inflation, Uncertain and volatile global environment). We expect further rate hike dependent on data (global cues like US inflation, Fed policy, domestic inflation trajectory, currency movement etc).
- Monetary Policy Committee wants to bring inflation below 6% in near term and ~4% in medium term. So even after reaching terminal rate, RBI is likely to remain on pause for longer time period, unless sure about durable nature of decline in inflation print (like Fed). But unlike US, where the decline in headline print is likely to be steep, similar decline is unlikely in India and hence the pause period in India is likely to be for extended time. Further currency, growth dynamics will have their role to play.
- On fiscal front, strong revenues receipts in Apr-Nov FY23 and robust nominal growth may likely help in achieving FY23 fiscal deficit target, despite rise in additional expenditure on various items (from subsidy to The Mahatma Gandhi National Rural Employment Guarantee Act 2005 (MNREGA)).
- Going forward, Budget expectations and actual budget number (fiscal deficit, gross borrowings) will be key drivers of fixed income markets.
RBI, Finance Minister, Press Information Bureau, India (PIB), Ministry of Statistics & Programme Implementation (MoSPI), CEIC, International Monetary Fund (IMF), JP Morgan, US Fed, The European Central Bank (ECB)
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