Indian markets were outperforming and we were very excited that maybe some sort of decoupling had happened, but basically if the whole world is going one way, it’s hard for India to completely stand out?
I don’t entirely agree with this thought process. Any economic uptick in the data increases the likelihood of an even faster rate hike by the Fed and what is causing panic in the markets is the faster than expected rate hikes.
Now extend this logic a little further. What should this faster-than-expected rate hike do? Demand is expected to kill quickly and when this process follows a real hard recession will follow because the only way the 1.5% to 9% inflation spike that has occurred in the US can drop into the Fed’s comfort zone, that is if demand is dejected. Inflation is partly supply-driven, partly demand-driven.
The natural logic of this thought process is that ultimately a recession is definitely on the way. A harsh recession is on its way. The problem is timing. The better the short-term economic news, the faster the future recession will be and in the scenario of a recession occurring in the advanced world.
Could you please continue and explain to us the point you were talking about regarding the fears of recession?
If a hard recession is caused by faster-than-expected rate hikes, there are two positive scenarios for India – from an economic and market perspective. So let me talk about the economy first. What a hard recession means is another crash in commodity prices and, more importantly, in oil.
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This means that all Indian sectors that get inputs from oil derivatives and commodity derivatives would get a marginal boost i.e. number one. Second, for the economy, it reduces the import burden, which is good news for the trade deficit and for the Indian government’s budget deficit.
The third thing is that the need for dollars to finance imports is decreasing, which is good news from a monetary perspective. So, from an economic point of view, all of these depreciate less than expected. This is a very marginal depreciation as the dollar will strengthen with rate hikes and so there will be a depreciation of the rupee with the dollar, but it will not be much better than that of other countries.
So, with better economic news, flows to the Indian market will also be strongly supported by two things. On the equities side when the rate hike happens some of the money moves from equities to debt and to that extent the Indian market will experience exits as US debt will be much more attractive but while about Rs 2.5 lakh crore worth of flows came out, only around Rs 60,000 crore odd came back.
The money flowed to commodity export markets in a scenario where commodity prices were rising. Now the reversal of flow will mean that they go back to commodity importing countries like India. So, the FII flows will reverse and come back to India because the issue of the taper is something that has just been addressed by the Fed, but has not been addressed.
There is still $8.5 trillion of Fed money left, which is only 50% of total global liquidity, which is fairly stable and available for investment. So, from this perspective, a coming recession will lead to a new round of quantitative easing (QE).
So forget about quantitative tightening (QT), a recession will mean there will be a need to pull the world out of recession and in this scenario global capital will flow back to India whether in the form of stocks or debt .
As India’s inclusion in the bond index is likely to happen sooner rather than later, we are going to see flows coming. Now these flows are not only good for the Indian capital markets – be it equities or debt – but they are also good for the currency because this strong inflow will mean that the currency will get further support and strength, so the Indian currency could be in an appreciation scenario for a brief while.
So from the perspective of the Indian market, with the margins of companies benefiting from the contraction in commodity prices with India’s growth story, there is an element that in times of recession, the Indian exports will fall. So our GDP growth, instead of 7.5% to 8%, might go down to 6.5% to 7%, but GDP growth of 6% will also make India the fastest growing country. faster in the world, while the rest of the world is in the recession and global growth will be at zero percent. India even at 6% will be like a shining light.
So, capital flows and FDI also with the PLI program and the increasing announcement of semiconductor factories, India is gradually replacing part of China. The China plus one strategy means that FDI flows will also remain strong in India.
These short-term volatilities are an excellent time to buy domestically oriented stocks, as it is obvious that export-oriented sectors like IT and pharmaceuticals during a recession would experience a drop in demand.
If I say that the rupiah will strengthen with the arrival of flows, it is also not good news for the export sector. So apart from the export-oriented sector, overall any domestic-oriented sector is poised to benefit from falling commodity prices, domestic demand remaining strong on the resurgence of the investment cycle. as well as consumption.
The durable consumer goods sector and consumption have strong oil-related inputs. Their margins will therefore be healthy and demand is picking up in the short term thanks to a good monsoon forecast. But in the medium term, post-Covid, the pent-up demand that continues to circulate means that investment and consumption, the two engines of growth, are at a solid counter for the next three to five years. Every dip is a golden opportunity to buy at this point.
You said you needed to look at domestically oriented sectors and that financial services would benefit. In the financial sector, do you think it should be the PSU banking space that outperformed the benchmarks as well as Bank Nifty?
I would say the story behind the finances is unique. The fact that they connected to long-term, low-cost sources of funding during the pandemic via rupee or masala bonds.
Second, NPAs have dropped dramatically; and third, the credit cycle is picking up. Fourth, overlay the fact that most of the banks’ loan book is now variable rate. Thus, the rate increases are passed on to the entire loan portfolio, but only to a part of the deposit portfolio which corresponds to the additional deposits.
It is therefore an ideal location for the banking and financial services space.
In terms of PSU banks versus private sector banks, I would say that PSU banks have discounted a lot of that growth already, but in terms of the professionalization of their services and the speed of execution there , I would always support the private sector to quickly seize opportunities, especially on the consumer lending side.
On the corporate lending side, PSUs have the advantage of being able to take much larger exposures to infra-related items. Also, their CASA balance, obviously because of their network but also there has always been a discount for the PSU banking sector versus the private sector. I think this reduction will continue. It will shrink and so there will be money to be made in good quality PSU banks from a narrowing of the price at the accounting gap between the public sector and the private sector.
I would still say that in terms of speed of execution, ability to act quickly, professionalism. I would always support the private sector to come away with the best deals on the market. There are specific PSU banks that are a good game, but a broader private sector game would still perform very well.
This is how I read the situation. And don’t forget the NBFCs in this pack. Good quality NBFCs are poised to exploit the opportunity in the Indian space.