With inflation unlikely to ease soon, chances of interest rates in the US staying higher for longer have increased. Prasanna Balachander, group head, global markets, sales trading & research, ICICI Bank, told FE that the Reserve Bank of India could hike rates by 25 bps at the next policy and retain its hawkish stance.
Where is the global economy headed? Have the chances of a soft landing increased after the spate of strong data recently?
US economic data has surprised positively even as we expect global economy to slow down. At the margin, we feel health of the economy is not as bad as earlier feared, and likelihood of a soft landing has increased. This is borne out of the fact that job additions and hiring have far exceeded expectations and other indicators like retail sales, PMIs as well as business confidence surveys have come out better than expected. Primarily, this is driven by an underlying demand for labour and elevated wage growth. So, growth will slow down but only gradually and the recession word is much less spoken now.
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Unfortunately, this also means that inflation may not ease to the extent we earlier anticipated. The market narrative of a Fed pivot has faded away rapidly to a narrative of higher rates for longer. Peak terminal rate expectations have moved to more than 5.40% from 4.80% earlier and the 50-bps rate cut that was priced in during H2CY23 has now been taken out. With the two-year bond yields moving up by 70 bps to 4.80% levels, the one-year rate now is at 4.76%, lending credence to the higher-for-longer theory.
How do you view India’s growth in the current scenario? Is investment-led growth likely to power India’s growth ahead?
We expect India’s growth to slow down primarily on the back of lower external demand and deceleration in discretionary consumption, which has been impacted by tapering-off of pent-up demand, high inflation, impact of lower IT hiring and layoffs in startups. While merchandise exports have contracted, services exports have been roaring which bodes very well for CAD and growth. Investment-led growth will continue to be driven by infrastructure spending as shown by several leading indicators. Government capex spending should also hopefully crowd in private capex going forward.
Analysts have been concerned about the external situation. Have the concerns really played out in terms of CAD?
India’s CAD was broadly estimated to be as high as 3.3% of the GDP, which is now estimated at 2.4% in FY23. Trade deficit has been revised downwards, led by lower non-oil and gold imports, as well as the impact of higher volumes from Russia and the discount on the same as visible in $6-billion reduction Q1 oil import bill. At the same time, both services exports and remittances are buoyant.We estimate CAD for FY24 at less than 2% of the GDP. Capital flows are still a concern, but with India’s medium-term growth trajectory, we should see inflows back after the Fed rate hike cycle is behind us. Global bond index inclusion is a potential dark horse for capital flows.
What is your view on the rate cycle, are we closer to the peak?
Owing to recent upward adjustment in Fed terminal rate expectations and resilient domestic inflation prints, we expect the RBI to hike the rate by another 25 bps in the April policy and keep a hawkish stance. Since we expect the Fed terminal rate to peak out at 5.50%, we expect the repo rate to peak out at 6.75%. But we cannot rule out the effective overnight being higher because of tighter liquidity conditions. The argument in favour of dissenters in the MPC is that monetary policy works with a lag. It is very difficult for them to continue to dissent based on current external conditions and if inflation continues to be higher.
Where are yields headed? Will the borrowing programme be as well managed next year as in FY23?
Indian bonds have been range- bound between 7.30% and 7.50% in spite of a sharp upward adjustment witnessed in terminal rates, both globally and locally. Savings mobilised by insurance companies and pension funds have led to a demand in the long-end. Going forward, with the risk of a hawkish MPC continuing and resumption of heavy supply period, bond yields are expected to witness a slow grind upwards. Adverse liquidity conditions would add to RBI’s problems in managing next year’s borrowing plan. The RBI would be required to balance the demand-supply for bonds and the tight liquidity conditions would give it a perfect reason to absorb Rs 1.5–2.0 trillion.
The yield curve has witnessed massive flattening over last couple of months. Increased supply in the extreme short end has resulted in bear flattening. Going into next fiscal, we expect the curve to steepen as demand from insurance companies is expected to be lower because of new taxation policy.
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What is the view on the rupee, given BoP and dollar view in the global arena?
Repricing of higher-for-longer US rates has led to dollar appreciation with the DXY index rebounding to 105. However, unlike last year, the recent strength can be short-lived as the earlier drivers like policy divergence, EU energy crisis, china lockdowns and safe haven flows are all absent. We expect the dollar to see some short-term strength, but start getting weaker as and when the economy shows signs of weakening. As far as the rupee is concerned, concerns seem to have moderated because of buoyant services exports, lower imports of oil, gold and coal and higher remittances. The trade weighted REER is now below 100, compared with an average of 102. This should lead to a different RBI reaction function even as the central bank smoothens volatility on either side and accumulates reserves during periods of appreciation. We see the rupee at around 81.5-83.5 in near term and the 81-83 range next year.
