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Macroeconomics – Global and Indian Developments
Through its 3-pronged strategy [1] – Increasing interest rate, quantitative tightening, & keeping dollar strong; the FED is trying to tame inflation. The first FED rate hike of 25 basis points happened on 16th March 2022, and the 10-year bond yield was at 1.716% [2] on 01st March 2022. The latest FED hike of 75 basis points took place on 21st September 2022, and 10-year bond yield was at 3.829% on 30th September 2022. From March to September 2022, the FED has increased the fund rate by 300 basis points (3.0%) – from 0.0-0.25% to 3.0-3.25%; and in the same period the 10-year bond yield has gone up by 2.113 ppt. In the case of the USA, rate hike is very well reflected/transmitted in the increasing long-term bond yield.
RBI’s 190 basis point hike in repo rate is not reflected in yield
On the other hand, in India RBI went for its first repo rate hike by 40 basis points on 04th May 2022, and 10-year bond yield was at 7.119% [3] on 02nd May 2022. The latest RBI hike of 50 basis points took place on 29th September 2022, and 10-year bond yield was at 7.398% on 30th September 2022. From May to September 2022, RBI has increased the repo rate by 190 basis points (1.9%) – from 4.0% to 5.9%; and in the same period 10-year bond yield has gone up by only 0.27 ppt. It reflects very poor transmission of rate hike into long-term bond yield.
If we consider March to September 2022 period for India, 10-year bond yield has gone up from 6.814% on 02nd March 2022 to 7.398% on 30th September 2022, that is just 0.584 ppt increase in bond yield. It is also a fact that despite 190 basis points hike in repo rate, banks have increased deposits rate by a meagre ~25 basis points and that only for a few depositing periods. In simple words it can be said that the interest rate has not gone up in India for the investors. Sometime back the governor had mentioned the following:
“Financial market stability and the orderly evolution of the yield curve are public goods and both market participants and the RBI have a shared responsibility in this regard.” [4]
However, we see it as financial repression, as the markets rates do not represent the economic conditions. Commercial banks are also contributing to poor transmission by keeping deposit interest rates low, which helps government and business cost of borrowing at the cost of savers.
INR looks overpriced and is continuously under pressure
The difference between 10-year Indian Bond Yield and 10-year USA bond yield is just at 3.569% as on 30th September 2022, which considering the risk of currency may not be enough for the investors.
On 01st March 2022 the exchange rate was at INR 75.752 to a US dollar [5], which became INR 81.509 per USD on 30th September 2022. During the period March to September 2022, INR depreciated by 7.6%. RBI is trying to stabilize it by increasing the repo rate, but it seems markets have different views on its approach.
In coming months – November & December 2022, the FED will most likely increase rates further by 75 and 50 basis points, which will again impact exchange rate and would force RBI to ensure not only further hikes in repo rate but also effective transmission.
INR could be anywhere close to 100 to a dollar, given the differences in inflation level between the US and India [6], if it were not for FII investment. During the recent years, we do have large FDI investment too going up and that offsets INR depreciation to some extent. Given that we would continue to run current account deficit in the near future, INR at 80-82 range is overpriced and that encourages imports from China, particularly when the businesses know that RBI and/or GOI wants INR to remain strong.
Under the given situation even Indian corporates and Individuals earning in USD would prefer to keep earnings/savings invested in the USA rather than bringing in India. That will put additional pressure on currency and might necessitate more rate hikes by RBI.
Downside pressure on commodities may continue
In the USA CPI basket, Shelter has a weight of ~32.39%, which is the highest among all the categories. In the process of controlling inflation, prices and growth of the housing sector could also be adversely impacted. Of-late China has also taken steps to cool down housing and real estate markets.
Strong USD and efforts to deflate the housing and real estate sector is expected to bring down the commodities prices. In India commodities are mainly priced at IPP – International Parity Price. So, prices would come down along-with international prices irrespective of India’s Growth stories. Due to ongoing supply related issues in Europe, there may be some spikes in the prices of some commodities for limited period, but the downward trend will remain unchanged.
It is indeed important to have commodity prices moderating sooner than later, and we do think that 3-pronged strategy would work. At this stage of growth cycle, commodity prices seem largely driven by traders chasing speculative gains in commodity markets, where some firms have been trying to sell half-truths in the name of commodity super-cycles [7]. Firms would continue to push prices up as long as interest rates remain low. At the same time, these firms try selling the narrative that world economy is going to collapse, if interest rates are raised. If the world economy has no traction without zero/low-rates and liquidity on tap, the only way the commodity super-cycle can get realized is, if the central banks go back to zero-cost liquidity on tap.
Indian markets may not remain decoupled
This year till 07th October 2022, S&P 500 has fallen by 23.64% [8] while NIFTY 50 has come down by just 1.80% [9] and that is the reason Indian markets appear to be highly valued in comparison with other markets. Under decreasing prices of commodities, lower earnings of the firms, and increasing interest rate; the NIFTY’s current level may not be sustainable in coming months. At the same time, our sense is that the Indian market may not fall as much as the US market, as it attracts a lot of speculative money – Indian as well as global.
Today considering real negative interest rates, different taxation rules for different classes of investments, risks associated with real estate investments, etc, Indian investors don’t have the choice but to invest their savings in equities. We think considering the downside risk of markets and for the overall well-being of the economy, which is driven by private consumption, it is important that the RBI allows the interest rates to be market determined and does not resort to financial repression.
Any correction in markets will erode financial savings of households and compromise India’s ability to consume and invest.
At the end, we think it is about correction of valuations across the asset classes which is triggered by the cycle of rate hikes. This correction will happen irrespective of growth stories of any country and/or any firm.
Note: I would like to thank you Prof Anil K Sood for his helpful inputs for this paper.
References
[1] https://www.ideassansideology.org/feds-3-pronged-strategy-and-global-economic-developments-a-short-note/
[2] USA 10-year bond yield data from – https://in.investing.com/rates-bonds/u.s.-10-year-bond-yield-historical-data
[3] India 10-year bond yield data from – https://in.investing.com/rates-bonds/india-10-year-bond-yield-historical-data
[4] A Macroeconomic View of the Shape of India’s Sovereign Yield Curve, Michael Debabrata Patra, Harendra Behera and Joice John, Reserve Bank of India.
[5] Exchange rate data from – https://in.investing.com/currencies/usd-inr-historical-data
[6] During the last three decades, the difference in inflation has been about 4.8% per annum between the two countries, with the average US inflation at 2.2% against India’s inflation being at 7.0%.
[7] Goldman proclaims the dawn of a new commodity super-cycle: Andy Home | Reuters – https://www.reuters.com/article/us-metals-supercycle-ahome-idUSKBN29A1QM
[8] https://www.spglobal.com/spdji/en/indices/equity/sp-500/#overview
[9] NIFTY 50, 03rd Jan 2022 close at 17625.7; 07th Oct 2022 close at 17314.65; data from -https://finance.yahoo.com/quote/%5ENSEI/history/
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