In the last 6 months, while global nominal economic activity has decelerated meaningfully, real growth has remained positive despite the aggressive pace of rate hikes. Stronger balance sheets, robust employment conditions and the absence of any large financial accidents have helped economic agents withstand this normalisation cycle better than counterfactuals would suggest. The higher nominal yield curve, tightening lending standards and the lagged effect of policy hikes indicate that the pressure on demand conditions will continue ahead. However, corporate earnings have broadly beaten expectations and risk markets have rallied from February lows indicating peak stress on margins may be behind us and that corporates retain pricing power. Given this, one can make the case that the worst of the inflation scare is now over and the path towards normalcy has begun. However, inflation is likely to remain elevated compared to pre covid levels.

Central bankers not in a hurry for rate easing

Over the last year and a half, central banks have been behind the curve on the assessment of inflation and are likely to seek assurance on that front before indicating any rate easing move. In fact, central banks are unlikely to come to the rescue with rate cuts as demand slowdown is engineered to bring down inflation closer to policy targets unless there is a threat to financial stability.

Any pre-emptive easing could reverse the orderly disinflation process as goods prices stop declining and services inflation remains sticky. Recently, two large central bankers (Australia & Canada) resumed their rate hikes after a brief pause as disinflationary tendencies aren’t widespread enough to reach their policy goals. Thus, we believe global policy response is likely to be highly uncertain and delayed and needs to be priced in while investing.

RBI committed to bringing down inflation to its target range

RBI has been very proactive and has proven to be a prudent central banker given the uncertain macro environment we are living in. Last year, RBI raised the operative rate in line with developed market central banks despite our inflation being closer to the target band and no large fiscal stimulus being unleased to stimulate demand. Slowing inflation readings and improving the external situation gave the confidence that financial stability is secured, and rates are near to peak in this cycle. Probably, that’s the reason RBI paused in April policy against the consensus expectations of a hike.

Assurance of reasonable liquidity from RBI, cleaner balance sheet of banks and corporates, improving capacity utilization and investment push by central government have helped local growth momentum to gain traction despite the global slowdown we are in. RBI’s June monetary policy decision was an acknowledgement of these strengths and the MPC kept rates and stance unchanged. On the growth outlook, the MPC appeared comfortable with Q4 FY23 numbers surprising to the upside and high frequency indicators supporting continued expansion. On inflation, there was a subtle change in communication with the Governor stressing that inflation needs to align towards the 4% target on a durable basis. He pointed that the MPC used the flexibility provided by the tolerance band to weather the pandemic and war-induced shocks and that as uncertainty has reduced, it was time to focus back on the target.

Growth momentum will drive the monetary policy

Another reason to be cautious is that the fiscal deficit run rate now is 6% compared to 4.5% pre-covid. With growth normalising to pre covid levels, any pre-emptive loosening can backfire and result in higher inflation. With robust credit growth & leaner balance sheets, lower rates may not be necessary at this stage to support the economy. Going ahead, growth momentum will drive the monetary policy response rather than inflation readings and policy stance will only be reviewed if there is a threat to growth conditions.

To summarise, India’s growth is relatively resilient, and thus in our assessment rate cuts will be delayed. If anything, policy rates may stay higher for longer than the market is expecting. We do not expect any rate cuts in FY24. We think that most positives are already in the price and duration plays carry higher risks at this point. We expect the 10Y to trade in the range of 6.95-7.20% in the near term. We are positive on the growth outlook and upgrade our estimate for FY24 GDP growth to 6.25-6.5% which is slightly above consensus forecasts. The near-term risks arise from global spillovers, El Nino and its impact on the spatial and temporal distribution of monsoons in India.

Fixed income is finally offering reasonable “real yields” after yields have surged globally. This has boosted the allure of fixed income investment. We like the short end of the yield curve which allows us to earn healthy accruals without taking significant duration risk. Policy makers’ response has turned asymmetric with growth as preferred variable, and we expect rates to remain higher for longer. Thus, short-term funds may be a better play for accrual compared to long duration exposure.

The views expressed in this article are for knowledge/information purpose only and is not a recommendation, offer or solicitation of business or to buy or sell any securities or to adopt any investment strategy. Aditya Birla Sun Life AMC Limited (“ABSLAMC”) /Aditya Birla Sun Life Mutual Fund (“the Fund”) is not guaranteeing/offering/communicating any indicative yield/returns on investments. The sector(s)/stock(s)/issuer(s) mentioned do not constitute any research report/recommendation of the same and the Fund may or may not have any future position in these sector(s)/stock(s)/issuer(s). ABSLAMC has used information that is publicly available including information developed in house. Information gathered and material used in this document is believed to be from reliable sources. Further the opinions expressed and facts referred to in this document are subject to change without notice and ABSLAMC is under no obligation to update the same.

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