RBI Policy Meeting – More volatility to rock Indian equity markets, yet India to remain outperformer

The past week has been a week of interest rate hikes by central banks across geographies as the world scrambles to rein in one of the worst inflations in history. As many as close to 10 countries have hiked rates in the past two days (21st and 22nd), which include USA, England, Switzerland, Taiwan, Hong Kong, Norway, Saudi Arabia and UAE, among others. The quantum of rate hikes in these economies has been either 75 basis points (bps) or 50 bps, except for Taiwan which has increased its rates by 12.5 bps.

Come September 30, the Reserve Bank of India (RBI) will be announcing by how much it will increase the interest rates for the world’s fastest-growing economy.

In the backdrop of continued aggressive rate hikes by the US Fed, the ripple effect from a global macro perspective is being felt as the dollar index strengthened and rupee made another low. Along with this, the continuously evolving geo political tensions continue to fan supply-side inflation.

Experts are expecting the RBI to toe the US Fed’s line and remain hawkish. But the quantum of rate hike would be lower at 50 bps compared to Fed’s 75 bps.

“Given the challenge of currency pressures in the context of a hawkish Fed commentary, we expect that RBI might be induced to move towards a 50-bps hike in favour of maintaining macro stability,” said Vivek Goel, Joint MD, Tailwind Financial Services.

Inflation – The Devil

Inflation in the US is still above 8 percent and there is a long way to go to reach the target. “Fed Chair Jerome Powell’s speech this week was probably the strongest one in terms of demonstrating a commitment to controlling inflation,” said Mohit Ralhan, CEO, TIW Capital. It means that the rate hikes are likely to continue till it tops 4.5 percent.

The rise in inflation is primarily led by the rise in crude prices because of the Russia-Ukraine conflict and reluctance of the Organisation of the Petroleum Exporting Countries (OPEC) to increase output.

However, Prasenjit K Basu, Chief Economist, ICICI Securities, holds a different opinion, and said, “Contrary to noise, US inflation pre-dates the Russia-Ukraine war, and is largely a consequence of excessive monetary growth. US M2 grew faster YoY in every month between March 2020 and February 2022 than in any month in the previous 60 years.” The Fed is now scrambling to undo the damage it inflicted with those expansionary policies, which should have ceased no later than October 2021, he said.

While India has inflationary pressures, the inflation rate relative to our target rate is much more benign compared to the US and UK.

“The higher crude prices have also impacted India, but to a lesser extent due to availability of crude supply from Russia at less than market rates,” said Anand Varadarajan, Director, Asit C Mehta Financial Services Ltd. Hence, actions from RBI may not be on the same lines as the Fed.

Expectations from RBI Policy Meeting

The US Federal Open Market Committee (FOMC) will hold two more meetings (November 1-2 and December 13-14) this year and experts expect that it is likely to raise rates by 75 bps and 50 bps during this period. While after the upcoming September 28-30 meeting, the RBI Monetary Policy Committee (MPC) has only one meeting left on December 5-7.

RBI will weigh the impact of crude oil prices going lower, the amount of non-USD-based crude oil and other commodities India is likely to import, and other ways of attracting dollar flows via NRI remittances, among others, and then decide on the quantum of the rate hike. However, it is going to be much less than the US.

“If RBI doesn’t increase the rates, the rupee will depreciate as well as outflow of funds will cause further depreciation. And with a depreciated rupee and the oil imports at hand, we will end up importing inflation,” said Vikas Gupta, CEO and Chief Investment Strategist, OmniScience Capital. Thus, to stamp out the existing Indian inflation, outflow of money, rupee depreciation, and importing more inflation, RBI will be forced to raise rates.

“RBI is also likely to hint at further “potentially aggressive” rate hike in the December meeting so that the rupee doesn’t depreciate much after the November FOMC meeting,” added Gupta.

However, Basu of ICICI Securities, expects a rate hike of 25 bps in December by when he expects the CPI inflation to moderate to below 6 percent.

Stock market behaviour

Experts expect markets to remain volatile in the lead up to the RBI policy meet with mixed expectations on the course of action the central bank might take as well as likely risk aversion from foreign institutional investors (FIIs).

“Indian equities will become less attractive for foreign investors if the interest rates in the US increase. It could lead to capital outflow from India,” said Raghvendra Nath, Managing Director, Ladderup Wealth Management Private Limited. This will put further pressure on the Indian rupee. “We believe FIIs would take a more cautious approach towards their investments in India,” he added.

The markets have been consolidating since the last few weeks. Investors would be cautious ahead of the meeting and there could be some profit booking as well. “However, we do not see this to last long, because, since over the last few weeks all corrections have been used by investors for accumulation,” said Varadarajan of Asit C Mehta Financial Services.

Advice for investors

Though caution is advised, experts say that among emerging markets, India still remains the most resilient market and with strong underlying fundamentals, it will continue to offer much higher returns than other markets.

“We would advise investors to remain invested and not panic because of macro environment, as we expect a healthy third quarter for Indian businesses, especially the retail, banking, auto, hospitality and defence sectors,” Raj Vyas, Portfolio Manager, Teji Mandi.

Basu of ICICI Securities suggests that investors should adopt a relatively defensive portfolio, focused on dividend paying stocks.

However, conservative investors can prefer short to medium-term debt investments, while for equity investors, “we continue to believe the domestic markets are better positioned and will maintain their outperformance over their global peers in the medium term”, said Goel of Tailwind Financial Services.

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