The rate-hike cycle likely hasn’t ended

The Union Budget for FY24 amped up the allocation for capital spending while focusing on fiscal consolidation. A week later, the Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC) delivered a 250bps rate hike in its February 2023 policy review. The MPC reiterated its focus on withdrawal of accommodation, to ensure that inflation remains within the target going forward while supporting growth.

Since May 2022, the MPC has cumulatively hiked the repo rate by 250 bps, which large parts of the market have taken in their stride. ICRA’s rated universe has withstood this tightening quite well, with upgrades continuing to outpace downgrades even in the recent months. In aggregate, there have been 386 upgrades versus 125 downgrades in April-January FY23. As per ICRA’s analysis of its portfolio entities in the interest-rate-sensitive sectors like roads and power, the credit profiles of most entities are seen to possess the tolerance to accommodate the level of interest-rate hikes seen so far. They either have the pricing power that emanates from their contractual agreements or have the backing of strong sponsors.

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The weighted average lending rate on fresh rupee loans has increased by 137 bps between May and December 2022, much lower than the increase in the policy rates during this period. The transmission is likely to improve in the near term, with the February 2023 rate hike putting upward pressure on lenders to increase their loan rates.

The housing market has been quite strong in the last five quarters, with home sales benefitting from pent-up demand, low home-loan interest rates, certain state incentives, the flexible working model adopted by corporates due to Covid-19, and healthy job and income growth in the IT/ITES sector. Nevertheless, further increases in home loan rates will impact buyer sentiment and demand going forward, particularly in the affordable housing segment, wherein buyers are heavily reliant on home loans.

Despite the rate hikes, bank credit growth has been high at 16.7% y-o-y (as on January 27, 2023), following two years of muted growth during the pandemic. This reflects a combination of factors such as the recovery in economic activity, higher working capital requirements, a shift from external commercial borrowings (ECBs) to local financing as well as from the bond/CP market to bank credit.

Following the lending rate hikes and an expected moderation in GDP growth, the incremental non-food bank credit is expected to moderate to ~Rs 15-16 trillion in FY24 from ~ Rs 18-19 trillion in FY23. However, deposit accretion will remain at similar levels of Rs 14-15 trillion in FY24 relative to that expected in FY23.

At the end of February 2023, the GDP growth print for the third quarter of FY23 will be released. In spite of a robust festive season, the growth in economic activity is expected to have slowed in Q3 FY23 amidst continued base normalisation and slackening external demand. While merchandise exports have recorded a sobering contraction in the last four months, services exports and the associated trade balance improved appreciably in Q3 FY23. Moreover, investment activity was buoyant in Q3 FY23, with an improved performance of several investment-related indicators relative to Q2 FY23, such as the output of capital goods and infrastructure/construction goods and the value of new project announcements.

On balance, ICRA expects the y-o-y growth of GDP to moderate to 5.1% in Q3 FY23 from the 6.3% recorded in Q2 FY23. Encouragingly, the growth in GDP over the pre-Covid levels is expected to improve further, boosted by continued recovery in the services sector.

After displaying a sustained uptrend since July 2022, the ICRA Business Activity Monitor—an index of high frequency indicators—remained flat in January 2023 at the level recorded in December 2022. However, the y-o-y growth in the ICRA Business Activity Monitor rose to 12.4% in January 2023 from 8% in December 2022, on account of a favourable base owing to the third wave of Covid-19 witnessed in January 2022.

Looking ahead, the Economic Survey, released on the eve of the Budget, and the MPC have placed the real GDP growth in FY24 at 6.5% and 6.4%, respectively, a modest step down from the 7% projected by the NSO for FY23. It is likely that growth could clock a slightly lower 6% in the next fiscal. However, a rapid pickup in the Centre’s capex programme, including the states’ offtake of the generous interest-free capex loans being provided by the former, would provide a clear upside.

High inflation has remained a bugbear in the recent months. Following the surprisingly unpleasant CPI inflation of 6.5% for January 2023, the next print may soften somewhat. However, it is entirely unlikely to fall below the MPC’s upper threshold of 6%, making further rate tightening inevitable. (The author is MD and group CEO, ICRA Limited)