Inflation dominates Monetary and Fiscal policy deliberations
Globally, the month saw rising concerns about slump in China (driven by pandemic related lock-down) and related spill-overs, further increase in inflation across globe (war, supply issues, demand pick-up), monetary normalisation/tightening in full-swing along with quantitative tightening (QT). Commodities prices reflected k-shape performance, with fuel (oil, natural gas, coal) on upswing, while industrial metals (Zinc, aluminium, copper) contracting. To preserve supply security and to protect domestic prices, many countries are putting ban of exports of food & fuel commodities. The global narrative, however, started changing towards end of the month, with China relaxing pandemic related restrictions. Back home, the month was dominated by off-cycle first hike in key policy rate since Pandemic, fuel tax cut, upward revision in subsidy bill (food, fertiliser and fuel), better than expected 4Q FY22 economic and fiscal print and lower RBI dividend.
Indian economy grew at 8.7%y/y in FY22 (Previous estimate: 8.9%y/y, FY21: -ve 6.6%y/y) indicating resilience despite various waves of pandemic, war and supply issues. Growth was primarily driven by consumption, capex and robust exports from expenditure side and manufacturing, agriculture, construction and public administration from production side. While annual print looks robust, there has been loss of momentum in quarterly numbers. 4Q FY22 GDP growth moderated to 4.1%y/y (3Q FY22: 5.1%y/y). Omicron wave in January inflicted temporary loss in momentum in that month, thereafter war and supply issues proved to be headwinds.
Twin shock (Russia-Ukraine war and China lockdown) continued to impact monthly inflation print in India and across globe. After rising sharply in March, India’s Headline CPI print jump to record high level of 7.79%y/y in April (Mar 2022: 6.95%y/y, Feb 2022: 6.07%y/y and as against Apr 2021: 4.23%y/y). This was much higher than the consensus estimates of 7.4% y/y. Apr 2022 headline print was highest since May 2014. Rise in inflation was driven by food, fuel, clothing and services
Like March, Sequential momentum in headline was much higher than the seasonality and was broad-based indicating direct and indirect pass-through of rising crude prices and global supply issues. Core inflation (excluding food, pan and fuel) rose sharply to 7.24%y/y (Mar 2022: 6.53%y/y and after remaining ~6.20% lvls between Oct 21-Feb 22).
Headline number is now almost 2% over the higher bound of RBI’s target range and expected to remain elevated in 1Q FY23 on global macros (elevated commodities, lingering supply chain issues) and domestic factors (rising cost of production, pick-up in demand). In May policy, RBI Governor has given clear indication that the inflation was key concern and bringing back policy rate to pre-covid levels was top priority, so rate normalization was way forward.
In surprise policy meeting in early May, RBI hiked the key policy rate by 40 bps to fight inflation on war footing. Further, in move to reduce humungous system liquidity and improve efficacy of the rate hike, RBI hiked the cash reserve ratio (CRR) by 50 bps. Further, Governor gave clear indication to remove the accommodation provided under pandemic at earliest – signalling 75 bps hike in upcoming meetings to bring policy rate back to 5.15% (pre-pandemic levels). Accordingly, in June’22 policy, RBI raised the key policy rate by 50 bps to 4.90%. This move was in line with path set out in May’22 policy and hence was along the consensus expectations. Expectations are now build-in for 25 bps hike in Aug’22 meeting. It also revised upward FY23 inflation projections by 100 bps to 6.7%.
As indicated in previous note, globally, most central banks have already embarked on the path of normalisation. Now with inflation risk lurking in backdrop of rising geo-political risks, monetary policy tightening is being followed by vigour. After starting normalisation process (25 bps hike) in March, US Fed hiked the policy rate aggressively by 50 bps, with plan to hike rate in subsequent meeting in 2022 and of similar size over next couple of meetings. It also announced a plan to start its QT programme from June. Bank of England continued with its rate normalisation process in May’22 (it has been hiking in every meeting since Dec 2021). There are early indicators that with sharp rise in inflation, ECB plans to start raising the rates as early as 3Q CY2022.
India’s External Sector & Global Update
With war extending beyond quarter, Crude prices remained elevated and volatile on geo-political & growth concerns. After declining by ~9% in Apr’22, brent crude started inching up since start of month and elevated in second half of the fortnight. Crude rose by ~7%m/m to average ~US$112.62/barrel (Apr: US$105.8/barrel, Mar: US$115.6/barrel). Crude remain above US$110 mark for most part of the month. YTD CY22 crude rise has been sharp (45%). Given uncertainty related, low inventory levels, supply issues and war, the crude prices are expected to remain elevated in coming months.
In the bond markets, US treasury yields remained elevated during the month on account of high inflation print, hawkish monetary policy, elevated crude prices and geo-political risk. The US 10 Yr Treasury bond yield started the month at elevated levels of 2.99% on rate hike expectation and rose further post policy to touch intra-month high of 3.12% on May 6, thereafter it declined to touch low of 2.74% towards end of month. It, however, close the month higher at 2.85% on opening up in China and higher crude prices. (Apr end: 2.89%, Mar end: 2.32%, Feb end: 1.83%, Jan 2022 end: 1.79%, Sep through Dec 2021: 1.5%-1.58% range, Aug end: 1.3%, July end: 1.24%). On risk -off scenario, Dollar Index continued to grow robustly by 3% m/m in May and even crossed 104.85 mark mid-month. In fact dollar index was very strong in first twenty days of month (avg: 103.68), only to ease to average 101.84 in last 10 days. YTD Dollar index has rose by ~7.7%.
Back home, INR was under pressure on global cues (aggressive monetary & liquidity normalisation across globe resulting in tightening financial conditions, high crude prices, rising current account concerns, FPI outflows), with RBI intervening the market to reduce volatility in currency market. Rupee was ~77.27 during the month (Avg Apr: 76.09/US$, Mar: 76.26/US$, Feb: 74.96/US$, Jan: 74.44/US$). Going forward, rupee is likely to come under pressure on global cues. Like other emerging economies, India has been witnessing net FPI outflows since Oct 2021 on risk aversion. This trend continued into May. Global financial market volatility saw net FPI outflows of US$ 4.7 bn in May (Apr: US$3 bn, Mar: US$S6.5 bn, Feb: US$5 bn, Jan: US$3.8 bn) - driven mainly by equity outflows. Since Oct, there has been net outflow of ~US$29 bn.
Yield Levels & Spreads:
Yields rose sharply post surprise RBI monetary policy meeting early May-22. 10 year G-sec move up from 7.12 pre-policy to 7.37 post policy and rose to intra-month high of 7.47 by May 9, 2022 and then eased to around 7.35 levels taking cues from oil, rupee and US yields. It moved up towards end of the month to close at 7.42 levels (Apr’22 end close: 7.12%, Mar’22 end close: 6.84%). 10 Term premium (10 yr over 365 days) came down to average ~166 bps (Apr’22: 238 bps, Nov-Mar’22: 222-228 bps range, Oct: 244 bps, Sep: 253 bps, Aug: 259 bps) indicating declining premium and curve flattening on changing RBI pivot.
Like Gsec, 10 yr SDL yields rose post RBI policy in early May’22. It stood at 7.35 lvls pre-policy, jumped to 7.71 lvls post policy, then eased to average 7.63 levels till month end. It closed the month higher at 7.77 levels taking cues from G-sec. (Apr-end: 7.27%, Mar end: 7.18%, Feb end: 7.10, Jan end: 7.24, Dec end: 6.99%, Nov end: 6.81%, Oct end: 6.92). SDL primary supply improved to Rs.57,740 cr in May’22 as against miniscule ~Rs.10,000 cr in Apr’22 (Mar: 1,03,665 cr, Feb: 52,118 cr, Jan: 79,535 cr, Dec: Rs.54,385 cr, Nov: Rs. 43,502 cr, Avg Aug-Oct: 55,000 cr). The spread between 10 yr SDL over G-sec stood at 29 bps (Apr: 21 bps, Mar: 35 bps, Feb: 37 bps, Jan: 53, Dec; 47, Nov: 54 bps, Oct: 57 bps, Sep: 61 bps, Aug:71 bps).
Taking cues from G-sec and SDL curve dynamics, AAA bonds rose post policy. 10 yr AAA PSU stood at 7.46% pre-policy, rose sharply to 7.91% post policy and close the month at 7.89% (Apr end: 7.35%, Mar end: 7.05%, Feb end: 7.02%, Jan end: 7.10%, Dec end: 6.84%, Nov end: 6.88%, Oct end: 6.91%, Sep end: 6.80%, Aug end: 6.93%).
- Normalization of Liquidity Adjustment Facility (LAF) corridor via hike in lower bound of LAF corridor (in Apr’22), surprise rate hike by RBI (in early May’22 policy) followed by 50 bps hike in Jun’22 meeting with hint for many more can be an indication of change pivot. Especially May’22 hike is clear indication of front-loaded and aggressive nature of policy. Now inflation has taken clear precedence over the growth and based on evolving inflation trajectory, upcoming policy meetings seems like live policy.
- Persistently strong inflation has forced central banks globally to front-load and exercise larger hikes. RBI’s actions since Apr’22 are steps in same direction. Unlike baby steps (25 bps) option exercised during the pre-pandemic times, record high headline inflation print (along with broad-based and sticky nature) has compelled RBI to do more (>25 bps hike) and faster (Apr, May, June) since Apr’22 policy.
- As expected, RBI revised upward FY23 inflation projection and maintained growth outlook. Despite rising headwinds for growth and tailwinds for inflation, projections seem more in line with consensus expectations and hence realistic. So, while there are lot of uncertainty to outlook, RBI’s future rate actions are likely to be calibrated and measured (unless there is shock).
- In early May’22 meeting, the US Fed hiked the key policy rate by 50 bps (in line with market expectations). Further, it decided to kickstart QT (quantitative tightening) from June 1, 2022 (early start) Normalisation process (rates and liquidity) of US Fed has already started impacting yields and flows to emerging markets (including India). While the latest move was already anticipated by the market, the market will watch out of future rate & QT trajectory and sound bite from US Fed.
- With crude inching up since May’22 start, there are growing concerns about economic growth and inflation (domestic and global). As a result, the Indian government has cut the fuel tax, increased subsidy substantially to give fiscal support to growth. While this will have fiscal implications, the move may certainly have positive impact on growth and inflation.
- Fiscal deficit for FY22 came better than expected at 6.7% of GDP (RE: 6.9% of GDP) on robust tax buoyancy and better GDP print. Apr;22 print indicates that tax buoyancy continued into current FY.
That said, the evolving geopolitical risk may continue to be determining factor for growth, inflation, fiscal, trade, currency, supply chain and financial market outlook.
Bloomberg, RBI, CEIC, Finance Ministry of India, Ministry of Statistics & Programme Implementation (MoSPI), The Clearing Corporation of India Ltd. (CCIL), Ministry of Petroleum and Natural Gas (MoPNG), NIMF Research.
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