India’s benchmark stock index Nifty snapped a 5-week losing streak and surged +0.88% last week to close around 19435.30 Nifty jumped +0.94% Friday on Modinomics optimism despite mixed global cues amid hopes & hypes of Fed pause/pivot/rate cut and Chinese slowdown/stimulus. The Indian market got a boost in early September as the Modi admin/ruling BJP is trying for ‘One Nation, One Election’ (ONOE) and may also go for the general election by Dec’23 instead scheduled May-June’24 for various political, and economic/budget, and weather-related issues.
Although ONOE is very difficult to implement even if the BJP/Government can pass it, the Modi admin may call for simultaneous general elections and state elections in those states, where Assembly elections are due in early 2024 and even late 2024 this time (like Mizoram, Chhattisgarh, MP, RJ, TL, AP, ANP, OD, Sikkim, Haryana, JHK and even Delhi). The market is expecting if such ONOE happens, then Modi/BJP may also be able to win in some of these states (Modi leadership appeal), where currently not in power.
This will pave the way for more BJP-ruled states, more development/fiscal/infra stimulus, and other policy implementations. Although simply ONOE does not guarantee a clean BJP win in various states-there are various local/state issues involved, but it’s brightening BJP prospects. Also, an early general election by Dec’23 (if happens), will pave the way for a full general budget by Feb’24 instead of an interim one; i.e. the December calendar of general election every five years will be positive for economic policies and implementations.
In India, various state elections and general elections are also acting as a big fiscal/economic stimulus. Thus every part of ONOE (in two phases state elections scheduled for CY25 may be held simultaneously at a time -ay by Dec’25 and so on) will also ensure such fiscal stimulus. In any way, due to a lack of a credible opposition party/leader and fragmented regional political parties, this time too PM Modi is set to return with a big margin; the question is whether it’s 400+, 350+, 300+ or 250+ seats (against the 2019 verdict of 300+ seats).
But growing popularity of various regional opposition political parties including INC at state levels may be an issue for coherent policy implementation of Modi admin across India. High inflation/cost of living and elevated unemployment/underemployment, especially for youth is a challenge for Modi (some incumbent sentiment), while he is embarking on development and anti-corruption platform. Most of the common people now want Modi’s development and anti-corruption model along with the nationalistic image.
Modi is also taking various necessary steps to boost employment and bring down inflation, which is a legacy issue for India, primarily a byproduct of devalued currency, imported inflation, and elevated flow of domestic black money. Last week, the Modi admin reduced the price of domestic LPG cylinders by 200/- to bring down the high inflation/cost of living of the general public, eyeing various state elections and also the early 2024 general election. In the recent Karnataka state election, Modi/BJP lost dearly mainly to high cost of living (inflation) issues, especially involving fuel including edible oil, LPG and food.
Nifty scaled a new lifetime high of 19990.80; i.e. almost 20000 on 20th July. Overall Nifty was primarily supported by an FII boost amid improving domestic macros, the appeal of Modinomics, and India’s 6D (demand, demography, democracy, deregulation, development, and digitalization), coupled with political & policy stability and hopes of Fed/RBI pivot.
The Indian capital market is also enjoying a valuation/scarcity premium among comparable emerging market economies (EMEs), and FPIs are now scrambling for India, considering the currency/macro/policy/political stability along with well-managed blue chip companies, improved corporate governance, strong banks & financials, and deleveraged corporates. India is now enjoying the benefit of a vibrant economy, stable macros/currency, and democracy, a rare combination in the EM world.
In August, the Indian market was mainly boosted by media, techs, and pharma to some extent, while dragged by energy, banks & financials, infra, FMCG, realty, metals, and selected automobiles amid subdued report card and Chinese slowdown.
On 10th August, as highly expected, RBI holds all its key policy rates. RBI kept the benchmark policy repo rate at +6.50%, effective reverse repo rate (SDF) at +6.25%, MSF (Marginal Standing Facility), and Bank rate at +6.75%. But RBI unexpectedly imposed a new CRR (Cash Reserve Ratio), called I-CRR (Incremental Cash Reserve Ratio) @10% on the increase of NDTL (Net Demand and Liabilities—mainly customer deposits) between 19/05/23 to 28/07/23 to absorb excess banking liquidity as a result of return of 2000/- notes and some other factors. This temporary I-CRR is effective from 12/08/23 and will be reviewed again on the 8th of September of the Festival season to ensure adequate banking liquidity for the productive sector of the economy. The existing CRR remains unchanged at 4.5%.
Also, the overall stance of the RBI may be termed as hawkish hold as RBI Governor Das clarified again the present mode as a ‘pause’, not a ‘pivot’; i.e. RBI may go for further hikes in the coming months depending on the actual domestic inflation trajectory and Fed action. Das also expressed caution as India’s core inflation remains substantially above the +4.00% target, while food inflation skyrocketed in recent times. The market was expecting an indication of rate cuts by the RBI in late 2023, but RBI didn’t provide any such forward guidance. As a result, the market is now expecting some rate cuts after FY24 rather than late 2023.
Subsequently, Nifty stumbled to some extent after the RBI presser/Q&A, as Governor Das clarified that the policy action must be seen as a temporary pause, not a pivot. RBI chose to hold the repo rate for 3rd consecutive time at +6.50% after raising +250 bps in the last FY23 to assess the impact of a cumulative hike on the real economy. RBI repo rate is now at Jan’19 levels after 6th consecutive hike from May’22 to Apr’23.
RBI maintained India’s real GDP growth estimate for the FY24 at 6.5% while raising its inflation (CPI) forecast to 5.4% from 5.1%. India’s headline inflation (CPI) sharply jumped to +7.44% in July from +4.87% in June, the highest since April ’22, and significantly higher than market expectations of +6.4% amid surging food and increasing fuel inflation. July marks the first month since March- inflation stays above the upper limit (+6.00%) of the RBI target, as irregular monsoon patterns across the country led to a spike in food prices along with elevated logistic costs and regional/rural elections in some states (political donation by local business).
Previously, India’s total CPI eased to +4.3% in May’23, at its lowest since late 2022. In July, India’s total CPI jumped +2.87% sequentially (m/m).
But India’s core CPI eased to +4.90% in July from +5.10% in June and remains around +5.0% in 2023 against +6.0% on an average in 2022. The 3M (NYSE:MMM) rolling average of underlying total CPI may be now running around +9.90%, while the 2023 (YTD) average is now around +5.7% against +6.7% in 2022.
Fed’s likely policy action in the rest of H2CY23:
Overall, the YTD (2023) average of underlying core CPI inflation is now around +5.3% and core PCE inflation +4.5%; overall average core inflation (CPI+PCE) is around +4.9% (~5.0%) against the Fed’s current repo rate of +5.50%; i.e., the real repo rate (wrt core inflation) is now around +0.5% (real positive) and at the mid-zone of Fed’s restrictive rate zone (5.00-6.00%).
Although the Fed officially targets core PCE inflation, Fed Chair Powell makes it quite clear that the Fed is now also targeting core CPI inflation to bring it down to +2.0% targets. Also, core service inflation is still quite elevated and sticky, although goods inflation has turned almost negative (deflation). The divergence between core PCE and core CPI inflation continues to be around +1.0% due to differences in constituents and weightage.
In this way, the Fed is now preparing the market for another hike in November and then a possible end of the tightening cycle by Dec’23. Overall, the U.S. labor market and core inflation trajectory are still hot enough for another Fed hike. Fed never surprised the market with its rate action and by mid-October (after core inflation and labor/wage data for July-September), it will be clear whether the Fed will go for another +25 bps hike in Nov’23 before going for a pause in Dec’23.
As per Taylor’s rule, for the US:
Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(5.50.00-2.00) =0+2+3.50=5.50%
Here:
A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation (CPI+PCE) =5.50% (for 2022); now average core inflation (CPI+PCE) is around +5.0% for 2023 (YTD); 6M average core inflation (2023) around +4.95%
Fed may go for a pause on 20th September but may hike another +25 bps on 2nd November, if core inflation does not fall significantly. Fed may go for a long pause to assess the underlying core inflation trend and outlook along with the labor market for July-Sep’23 economic data. Fed may project at least another hike in 2023 in its September dot-plots (SEP) depending upon the actual economic data and outlook. If there is no significant easing of core inflation, especially core service inflation, then the Fed may go for another +25 bps hike in Nov’23 and possibly the end of a tightening cycle.
Fed may now go for a long pause, at least till 1st November’23, to assess the underlying core inflation trend and outlook along with the labor market for July-September ’23 economic data. If core CPI inflation indeed eased further to around +4.0% by Oct’23, then the Fed may refrain from any further rate hike in 2023 and may also indicate some rate cuts in Q2CY24 in the Dec’23 SEP (ahead of the US Presidential Election in Nov’24) to keep real repo rate around +1.00% levels (restrictive zone).
At the current run rate/trend, core CPI inflation should be around +4.0% by Dec’23, +3.0% by June’24, and +2.0% by Dec’24; i.e. at target ahead of the Fed’s estimate of Dec’25. But looking at the overall trend, higher oil prices, and core CPI inflation may also spike again in August-September.
Also, oil prices may stay elevated in the coming months between $75-85 instead of the earlier $65-75 despite US efforts to bring more supply from Iran, and Venezuela (by lessening sanctions) as OPEC/Saudi Arabia will not ‘cooperate’ with the U.S. for ‘breach of trust’ in refilling SPR (as agreed ‘verbally’).
Elevated oil prices around $80 will continue to boost energy/transportation costs and core inflation. Saudi Arabia/most OPEC producers and even Russia are now seeking $80 oil prices on a sustainable basis to fund budget deficits, EV transition, and also the cost of the Ukraine war. China may also deploy more targeted stimulus to bring out the economy from the deflationary spiral in the coming days, which may also support elevated oil prices.
The U.S., as a producer, is also benefitting from elevated oil prices. The U.S. is also a beneficiary of the Russia-Ukraine war and other geo-political tensions involving North Korea, China, and Iran. The U.S. defense/military industry is now booming. Also, the lingering Cold War mentality with China is resulting in supply chain disruptions and elevated inflations. The global economy continues to face the daunting challenges of macro-headwinds- elevated inflation, high levels of debt, tight and volatile financial conditions, continuing geopolitical tensions, fragmentations, and extreme weather conditions.
In any way, if average U.S. core CPI inflation indeed falls below +4.0% by June’24 (H1CY24) on a sustainable basis, the Fed may go for a +25 bps cut each in July’24 (just ahead of the Nov’24 US Presidential Election) and thereafter every alternate meeting to keep the real repo rate around +1.0% (from 3M/6M average core inflation).
Looking ahead, from March ’24, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut from June’24 (H2CY24) to ensure a soft landing while bringing down inflation. Also, the Fed has to ensure lower borrowing costs for the U.S. Government (Treasury) endless deficit spending and mammoth public debt of almost $32T. The U.S. is now paying around 9.5% of its revenue as interest on public debt against China/EU’s 5.5%. This is a red flag, and thus Fed has to operate in a balancing way while going for calibrated hiking to bring inflation down to target, avoiding an all-out recession; i.e. to ensure both price stability and soft-landing.
RBI may continue the hawkish hold stance with an eye on the Fed’s policy action in the rest of 2023:
The RBI may want to maintain the present policy rate differential of 1.50%-2.50% with the Fed depending upon the actual core inflation differential/trajectory. Thus RBI paused in August but has not pivoted as RBI may want to see actual Fed rate action and SEP on 20th September and any guidance for the November/December meeting.
As per Taylor’s rule, for India:
Recommended policy repo/interest rate:
(I) = A+B+(C+D)*(E-B) =0.50+4+ (1.5+0)*(5.5-4) =0.50+4+1.5*1.5=0.50+4+2.25=6.75%
Here for RBI/India:
A=desired real interest rate=0.50; B= inflation target =4; C= permissible factor from deviation of inflation target=1.5 (6/4); D= permissible factor from deviation of output target from potential=0; E= average core CPI=5.5% (for FY: 23-24)
Thus assuming the estimated average core inflation is around +5.50% in FY: 23-24, the restrictive target of the RBI repo rate may be around +6.75%. If the Fed continues to hike another +25 bps in H2CY23 (even after Sep’23 expected pause) to +5.75% by Dec’23 (in case U.S. core inflation remains sticky/elevated above +5.50%), then RBI also has to hike (under still elevated/sticky core inflation). Thus RBI may also like to keep the repo rate at 6.75% in CY23 (depending upon the Fed rate action and actual Indian core inflation trajectory/outlook).
As USD is the reserve/global currency, every major Central Bank has to follow Fed action to maintain bond yield/currency and policy differential (whatever may be the inflation/growth narrative) to control imported inflation. India’s real rate was around +1.25% in Feb’19 if we consider the then repo rate of +6.50% and core CPI +5.25%. Now around +5.00% average core CPI and +6.50% RBI repo rate, the real repo rate is around +1.50%, consistent with RBI’s restrictive preference of 1.50% (1.00-2.00%).
Under Governor Das and Modi admin, RBI may prefer to keep the real rate of interest around 1.50%. As India’s core CPI is now averaging around +5.50%, RBI may keep the terminal rate between 6.50%-6.75% in the coming days depending upon the actual Fed rate action and domestic core inflation trajectory. As there are a series of state elections in 2023 and also a general election by May’24, the Modi admin now prefers lower inflation than emphasizing too much on economic growth.
Thus RBI may keep the terminal repo rate around 6.50-6.75% if the Fed does not go beyond +5.75% and India’s core CPI stays around +5.50%. Modi admin/BJP is now quite concerned about general elevated inflation, especially for food and fuel, which cost them the recent Karnataka state election dearly. In his recent speech on 15th August, India’s PM Modi also emphasized repeatedly on price stability.
Overall, RBI is quite optimistic about India’s GDP growth but is still concerned about elevated sticky core inflation. But RBI is also quite optimistic about maintaining India’s price, financial, and growth stability through its calibrated policy action. As India’s core CPI is still substantially higher than targets, while real GDP growth is almost in line with the potential trend/target, RBI is still open for another calibrated +25 bps rate hike. If the Fed indeed goes for another rate hike in H2CY23 for a repo rate of +5.75%, RBI may go for at least another +25 bps rate hike by Dec’23 for a corresponding repo rate of +6.75%. And if the Fed goes for no further rate hike in H2CY23 for a terminal repo rate of +5.50%, RBI may continue to hold at +6.50% in FY24.
Looking ahead, the Fed may not be in a hurry to cut rates in H1CY24 but may cut rates in H2CY24 (from July’24 onwards, just ahead of the Nov’24 U.S. Presidential election). In his recent speech, RBI Governor Das stressed higher for longer policy. Thus RBI also may not cut before Aug’24. In India, RBI also thus has to think about cutting from August ’24 onwards to match with the Fed; otherwise, if RBI goes for any pre-emptive cut in April’24, ahead of the Indian general election in May June, then USDINR may scale above 85, which would be a political issue.
But Modi/BJP may also advance the general election in Dec’23 for various political, economic/budget, and weather-related issues. In this way, this time PM Modi is set to return with a big margin; the question is whether it’s 300+ 350+, or 250+ seats against the 2019 verdict of 300+ seats. But growing popularity of various regional opposition political parties including INC at state levels may be an issue for coherent policy implementation of Modi admin across India.
In India, RBI also thus has to think about cutting from August ’24 onwards to match with the Fed; otherwise, if RBI goes for any pre-emptive cut in April’24, ahead of the scheduled Indian general election in May/June, then USDINR may scale above 85, which would be a political issue.
Market Wrap:
On Tuesday (5th September), Nifty inched up +0.24% to close around 19274.90 on mixed global cues amid subdued PMI data from China and Europe and also below expected Indian service PMI data, although at around 60.1, the Indian service PMI remains robust, although eased from 13-year high 62.3 scaled in July. The Indian GDP expanded by +7.8% annually in Q2FY24, the highest in one year and above market expectations of 7.7%.
Overall, Nifty gained almost +1.67% in the 1st three trading days in September by media, pharma, realty, FMCG, PSU banks, techs, metals, energy, infra, selected private banks, while dragged by automobiles and selected PSU banks. On Tuesday, Nifty was helped by ITC, Infy, RIL, L&T, Sun Pharma (NS:SUN) and Bajaj Fin, while dragged by HDFC Bank (NS:HDBK), Ultratech Cement (NS:ULTC), Maruti (NS:MRTI), SBI (NS:SBI), DRL and SBI Life (NS:SBIL).
Technical Analysis: Nifty Future (LTP: 19650)-EOD: 05/09/23
Looking ahead, whatever may be the narrative, technically, Nifty Future now has to sustain over 19750 for a further rally to 19900/20000-20050*/20100 and 20250*/20375-20650/21050 and further 21550/21650 in the coming days (Bullish case scenario). On the flip side, sustaining below 19700, Nifty future may again fall to 19550/19440-19300/19200* and further 1900018900-18800/18735* and 18660/18600* and further 18400/18000-17850*/17650 zones in the coming days (Bearish case scenario).