12 Apr 2023
Is the world facing a recession? The answer is yes, the probability is increasing. In Europe, it is little to the higher side owing to the Russia-Ukraine crisis, but the probability remains reasonably high in North America too.
Inflation continues to remain above the 10-year average in most countries across the globe. As interest rates start moving up to control inflation, the cost of servicing keeps increasing. A one percentage point increase in interest payment can cost significantly to corporates and leverage borrowers.
The central bank's game of increasing interest rates and taking out liquidity could have worked, provided there was no financial crisis. Unfortunately, the crisis at Silicon Valley Bank and Credit Suisse indicates there is a cost of raising interest rates and taking out liquidity to control inflation. This fear of financial contagion will likely impact global central banks decision-making going forward.
The Federal Bank in the United States has raised interest rates but also had to pump liquidity back into the system to ensure bank crisis does not become a contagion. They have taken out $625 billion in liquidity since the beginning of the rate-tightening cycle in the middle of 2022, but with the recent banking crisis, they have added back $ 370 billion in just a few days.
Markets are now expecting the Federal Bank to start cutting rates by the middle of 2023, and by December, these rates should be on the lower side of what it is today.
In this scenario, India is an oasis in a global desert, but some dark clouds are gathering on the horizon. On the positive side, economic activity is at an all-time high, and capacity utilisation is above the historical average. GST collection is above Rs 1.5 trillion, a positive sign for the government budget. The government is spending more on infrastructure, and capital expenditure as a percentage of GDP is likely to be 3.3 percent. Private sector investments may revive as their balance sheets have become fairly deleveraged. Consumer spending seems to be improving, while Indian banks are also well-capitalised, have healthy balance sheets and resources to support India’s growth.
However, the El Nino effect forecast this year during monsoons can adversely impact the agriculture sector.
Besides, RBI expects inflation to average around 5.2 percent this fiscal year, which could also be impacted by El Nino, and oil price movement.
Outlook for Equity markets:
Valuation-wise, India is neutral, and every market correction is an opportunity to increase allocation in equity.
Equity markets are expected to be volatile until May 2024 driven by global events like the US recession and the Russia-Ukraine war. Domestic events like corporate earnings and, more importantly, the outcome of general elections next year will also impact markets.
While markets have not delivered much returns in the past two years, the fundamentals of markets have improved, setting the stage for better returns in the coming days.
India remains a market on buy-on-dips. It is a market for systematic investment plans (SIP) and systematic transfer plans (STP) with a long-term view.
Debt Market Outlook:
Inflation remains elevated, putting pressure on the Fed to increase interest rates.
While RBI has hit the pause button on interest rates, it will take a view based on data and developments till the next monetary policy.
Liquidity is down without much impact on yield. We believe the 10-year yield will remain range bound in 7-.7.5 percent in days to come.
On debt markets, indexation benefits are gone with effect April 1, however, other benefits like anytime liquidity, diversification across 30-50 instruments, and tax deferment for high net worth individuals remain intact.
(Mr. Nilesh Shah is Managing Director Kotak Mahindra Asset Management Company Ltd)
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