The recent breakout of War between Israel and Iran with the spike in Oil prices and potential of sea route disruption has emerged as the biggest focus of markets. The war has just started and there is no clarity on how long it can go and more importantly on how wide it can escalate, which is the key source of uncertainty. Crude price has spike by US$10 since the breakout of war, but the current levels at close to US$75/bbl is lower than 2024 average of US$ 79/bbl. While lower crude prices are always better for Indian inflation, the current levels are quite manageable. While the geo-political tension in the middle east has reduced the market's focus from developments on the global tariff war front, it nevertheless remains an important risk to closely monitor. News from that front has shown some improvement with US-China reaching some type of temporary truce. The truce is expected to provide relief to markets and economic agents hit not only by tariffs but also uncertainty regarding the same. However, the current base case is that 9th July deadline on tariffs will be extended for some more time.
On the domestic economy front, 4QFY25 GDP growth surprised on the upside to 7.4% with GVA at also at 6.8%, taking FY25 GDP growth to 6.5%, which was higher than street consensus of 6.3%. The details indicated healthy pick-up in manufacturing and construction on GVA and investments on demand side. High frequency India growth indicators remained mixed in months of April-May suggesting a stable growth momentum with India PMI remaining one of the highest in the world with composite PMI at 59.3. Other high frequency have been mixed with moderation in bank credit and deposit growth, index of industrial production, and fuel and energy consumption but pickup in passenger airport traffic, FMCG volume and indirect tax collection. We expect the aggressive monetary easing by RBI to be growth positive, even as we are closing following the development in global tariff war front. Absent a major global growth shock, we expect India to grow ~6.5% in this fiscal year.
In a surprising, front-loaded policy easing, RBI cut rates by 50 bps to 5.5% beating market expectations for a 25 bps move. Besides the rate cut, RBI also announced a 100bp cut in Cash Reserve Ratio to 3.0% to be effective from September to November 2025. However, what dampened market's enthusiasm was that the stance was changed to neutral with the explicit statement that 'monetary policy is left with very limited space to support growth'. The move is evidently aimed at fostering growth amid an uncertain global environment. Given that monetary policy acts with a lag, the front-loaded policy action underscores a clear emphasis on growth, considering that inflation is currently below the Reserve Bank of India's (RBI) target. It is noteworthy that the Governor mentioned while current growth rates are satisfactory, the target is an aspirational growth rate of 7-8%. The attempt to push growth from monetary policy side towards a 7-8% trajectory is commendable. While the current consensus view on potential growth in India would be closer to 6.5%, we should note that higher trend growth itself acts to push up the growth potential. While market consensus is currently that 5.5% is the terminal rate of the cycle, if growth disappoints then RBI will not shy from further support to growth, if inflation permits.
Headline CPI Inflation for May-25 declined further to 2.8%, which is lowest reading since Feb 2019 and 118bp lower than RBI's 4% inflation target. The decline was due to further decline in food and beverage inflation which came at 1.5%, reversing the high food inflation trend of 2024. Besides the decline in volatile component of food inflation, like vegetables, recent months' data is showing decline in sticky component of food inflation as well, suggestive of longer-term food inflation moderation. RBI Core inflation remained at 4.1%, higher than overall inflation due to high Gold price. Our preferred measure of core-core inflation, which does not include gold, remained benign and below RBI's target of 4%
We expect inflation to remain well behaved in FY26 and concur with RBI's forecast of 3.7% and if monsoon turns out to be as good as forecasted then there is some further downside to inflation. Crude prices are also likely to remain well behaved and there is good chance of deflationary impulses due to current tariff war. Moreover, USD has likely peaked and should remain under pressure. Also, with liquidity expected to remain in comfortable surplus, we see overnight rate to remain little below 5.5% for the foreseeable future. As the below 5.5% overnight funding rate and CRR cut by RBI gets transmitted to the broader economy, including through banks deposit rate cuts, the current level of bond yields will look attractive to investors. We thus believe that path of least resistance for long bond yields is to drift lower from current levels. There is also good opportunity available in corporate bonds space where spreads are running above long term average, despite the comfortable liquidity regime.
Our short-term funds (Short term fund, corporate bond fund, and Banking & PSU fund) provide the sweet spot on risk-return basis and investors can look to invest in that space either directly or via our Debt Plus Arbitrage FoF. Actively managed duration funds should continue to do well this year, and with the recent upmove in long maturity GSec and corporate bond yields, Government Securities Funds and Income Fund also provide an attractive tactical opportunity for investors. Ultra short-term investors should look to invest in money market, ultra-short-term funds & low duration funds. We have also launched 100% AAA sectoral target maturity funds as well as 3-6M and 9-12M constant maturity sectoral index funds which can be a good addition to investor portfolios.
Source: CEIC, Bloomberg, RBI
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