We are concerned about the growth, the future rate hike expectation and its impact on India. What is your view keeping Wednesday’s Fed policy in view?
The Fed rate hike is a function of the fact that today inflation is far more important than growth to the US. Not only from the Fed’s perspective but the US political powers because there is an election due in December of the Senate. As we know, growth may not get you votes but inflation will definitely lose you votes.
On the political side, Joe Biden’s government is also putting pressure on the Fed to bring down inflation at any cost. That can happen in a demand-led economy like the US only by hiking interest rates. When interest rates are hiked, it is killing demand. So naturally US economic growth will slow down and ultimately slip into a recession.
But from an Indian economy perspective we are fairly decoupled from America because we do not have too much exports to America compared to the size of our GDP. The Indian economic growth will not get much affected by the US slowdown or possible recession.
Surely there are concerns but not only has it had an impact on all the growth-oriented sectors but the inverted yield curve shows signs of recession. How can one read this? The US key voices have been strongly denying that they will go into a recession. How do you take it?
Given the fact that the inflation has gone from 1.5% to 8.5% and is caused by a mix of supply side factors starting with Covid and then with the Russian Ukraine war and the demand side factor because of the stimulus given by Fed through QE and the stimulus given by the US government through the $3,600 give away to each American tax payer.
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I think the growth scenario in the US is going to get impacted if the Fed does not act on it. The route to this is only by hiking rates and killing demand. In that context, since the Russia Ukraine conflict is not showing any signs of ending, there is no choice but for the US to slip into a recession before the inflation can be brought under control. So in my view there is a 75% plus probability of a recession in America and the advanced economies like Europe.
You did touch upon the India decoupling factor. Indian markets are showing that resilience but now looking at the rate hike scenario along with the robust demand seen across sectors in the domestic market, how long can we sustain this outperformance?
I believe that we have entered a space where we are getting decoupled from the advanced world. The reason is that the US is suffering from an inflationary scenario, an attempt to kill demand and bring down inflation and a recession will lead to a drop in commodity price and drop in oil prices.
Among the emerging economies, India is the one economy which imports 83% of its oil and a significant amount of commodities. In a scenario where the commodity prices are coming down, an economy like India benefits from the reduced commodity prices in multiple ways.
First, domestic inflation will come down from imported inflation risk.
Second, our trade deficit and fiscal deficit will improve.
Third, the amount of dollars needed to pay for imports will come down hence the currency situation will improve.
Fourth, the Indian corporate sector which uses the oil related products as inputs will also face a reduction in their input cost and a widening of the margin. All these factors put together means that in a recessionary scenario in advanced countries, the Indian economy is poised to benefit.
Now the Indian market is also proving to be decoupled from the American markets because in the period between October and June, about Rs 2.5 lakh crore of money went out of India due to withdrawal by FIIs. But all of it did not go back to America. Some amount went from the equity market to the debt market of America as higher interest gives a good return there. Much of the money went to commodity exporting markets like Brazil, away from India.
Now with the deflationary and the recessionary scenario coming, that money is likely to re-shift from the commodity exporting market to a commodity importing market like India. FII flows will come and support the market.
The third point of view is that the Indian market has seen the strong support of domestic investors because in the Covid timeframe also, Indian per capita income grew but because of the lockdown, people did not have avenue to spend the money. So their savings increased and more investment in the equity market was seen.
The SIP book of Rs 12,000 crore is providing strong support to the domestic market. In view of this, the market is also turning to be decoupled and while there may be a short-term panic reaction if the Fed rate hike is announced because some FIIs may pull out money within a few days. We will find the reallocation of capital from commodity exporters to India as well as the domestic flows giving support and the market will bounce back.
I believe that India is in a sweet spot both as an economy which will benefit from an advanced country recession and a market which will benefit from flows in a decreasing oil price scenario. India is in a very sweet spot at this point in time. I would feel that in the land of the blind, a one-eyed man is king and that is the status of India today.
India is in a sweet spot and we are seeing a lot more confidence in the Indian market. In the near term, the market has turned very volatile. How do we balance our equity allocation?
The scenario in front of us today with India in a sweet spot with the world going into recession, the corporate sector is bound to have an increase in EPS. I believe that the macro economic factors for India are also turning positive; GST collections have gone up month on month. We have seen personal income tax grow 40% YOY and corporate income tax grow 30% YOY.
All state government income streams are also on a rising trend plus the government through the fiscal deficit expansion which it went through in Covid has invested the money wisely in the infrastructure programme.
Second, through the PLI scheme, India is trying to take advantage of FDI money coming in and a China plus one strategy being implemented in certain very labour oriented sectors. So the capital goods cycle will get a boost. The private sector, with the capacity utilisation crossing the long term average of 72% to reach 75% means that many sectors and industries are at 80% level and hence the need for them to expand capacity to meet demand in two-three years is happening.
This capex cycle will give a strong boost to Indian GDP growth in the coming days and hence we will find domestic oriented companies have a good order book and a good margin expansion. I believe that it is a sweet spot to increase your allocation to equity at this particular point in time.