The Nifty Index closed at an all-time high level in November. It gained 4.1% to close at 18,758. Mid-cap and small-cap indices underperformed large-cap indices and were up 2% and 3%, respectively. Almost all sectoral indices closed higher than the previous month, except for auto, consumer durables, and power. Metals, Oil & Gas, and IT indices were the top gainers and were up 6.5%, 5.8%, and 5.5%, respectively. Though geo-political tensions and rising Covid cases in China initially weighed on investor sentiment, but subsequently, investors cheered the lower-than-expected US CPI inflation that fuelled hopes that the Fed could tone down its aggressive pace of interest rate hikes and falling crude oil prices. During the month, FPIs bought US$4 bn worth of Indian equities in the secondary market, while DIIs sold ~ US$700 mn.

Q2FY23 Earnings Season: In 2QFY23, NSE500 universe reported sales/EBITDA/ adjusted PAT growth of 29%/3%/-3% YoY. The aggregate earnings were marred by a sharp drag from global commodities (i.e. Metals, Oil and Gas) and also Cement, which posted a sharp earnings decline); Financials continued to drive the performance. The NSE500, excluding BFSI, reported an adjusted PAT decline of 23% YoY. Earnings growth, excluding Metals and Oil & Gas, stood at 33% YoY in 2QFY23.

Growth in domestic high-frequency indicators continues to exhibit healthy trends bolstered by reopening vibrancy, pent-up demand, and festive demand. External indicators remain weak, with exports, in particular, moderating to their lowest since March 2021, due to global headwinds truncating the global growth trajectory. GST collection in November (reflecting activity in October) continued to track above the INR1.4tn mark for the ninth consecutive month (vs INR 1.52tn in October), while YoY growth slowed to 11% in November. PMI manufacturing was largely steady at 55.7 in November vs. 55.3 in October. Services PMI gained momentum as it rose to a 3-month high of 56.4 in November from 55.1 in October. Credit growth remained resilient at 17.2% YoY in November vs. 17.8% YoY in October.

A combined takeaway of what has transpired out of the result season and high-frequency economic indicators described above is that while India’s economy is on a steady growth path relative to probably other global markets, this appears sufficiently baked when translated into corporate earnings expectations and with the earnings upgrade cycle of the last 5-6 quarters now levelling off, India’s valuations multiples may find it challenging to expand further without adequate support from global growth and market recovery. While few central banks have either actioned lower doses of rate hikes or intend to do so going forward, global growth markers seem to suggest a further growth slowdown perhaps coming out of the lagged effect of the strong rate hikes in 2022. We reckon the combined impact of recent and future rate hikes can show up more decisively in the form of slower growth and lower inflation during 2023. For central banks around the world, the threshold for lowering the quantum of interest rates perhaps seems to have been attained, but that for ending rate hikes may have not.

While we remain sanguine about India’s structural growth drivers, the present global macro backdrop can pose headwinds for the near range domestic growth outlook. India's external sector growth can come under pressure even as domestic demand maintains strength. This may restrict the RBI’s ability to move the interest rate curve independent of global considerations. Also, India’s corporate sector growth in the post-Covid world has seen a strong positive influence from gains from the unorganised sector, the pace of which can likely slow in the coming times as the unorganised sector regains strength as supply chains normalise and India’s growth becomes more broad-based. Corporate debt levels too have normalised over the past two years, and it is therefore, imperative for a synchronised strengthening of the private and public investment cycles to commence for India’s future growth trajectory to develop long-term sustainability.

Our preferred portfolio stance has been India-centric growth sectors for much of this year, and this largely stays but pockets of value may have started to emerge in some of the global-oriented sectors such as technology, pharmaceuticals, and commodities. Some of these would also receive support for their earnings from a weak currency. Overall, we stay constructive on India’s improving economic cycle and inherent stability and believe the balance of this year will provide good opportunities for portfolio and investment planning for potential returns during 2023 and beyond.

Global backdrop turned lesser challenging with many Central banks, especially the US FOMC, hinting to tone down the jumbo rate hikes to a moderated one as the inflation trajectory is expected to moderate, further correction in commodity prices, lowering of global interest rates by 25 – 35 bps and most critically, relatively stable currency market with USD giving up on its strength to an extent.

Domestic interest rates also rallied in line with the global rate movement by ~15-25 bps across the yield curve, with upto 5-year segment performing relatively better. Corporate bonds as well rallied though marginally lower as compared with the G-Sec.

Domestic headline inflation expectedly softened to 6.8% y-o-y from 7.4% in September, largely led by a base-effect led drop in food inflation, especially vegetables. Core inflation remains entrenched at 6% YoY vs. 6.3% in the previous month, with most items witnessing no let-up in m-o-m momentum.

FPI inflows increased considerably to ~INR 390 bn (~INR 35 bn in previous month) led by healthy equity buying, while the debt inflow turned marginally positive during the month. Fx reserves reversed the declining trend of more than 6 months and surged by ~USD 20 bn to end the month at more than USD 550 bn. Pressure on INR eased off, to some extent, during the month as USD gave up its strength on the back of expected moderation in rate hike by US FOMC.

Outlook

As a welcome relief, the FOMC has indicated the possibility of a slower rate hike going forward, although it has also alluded to a higher terminal policy rate than earlier expected as the job market remains tight & on robust private consumption. Few other Central banks have already started with lesser quantum of rate hikes.

In the recent monetary policy, MPC has also moderated the rate hike to 35 bps, which is also the lowest quantum in the current rate hike cycle (40-50 bps rate hikes in last four policies). At the same time, MPC has continued to maintain its caution on inflation, highlighting the sticky core inflation, higher demand-pull factors, and global uncertainties that can pose upside risks to the inflation trajectory.

MPC decision to continue with “withdrawal of accommodation” stance indicates that the rate hike cycle is not over yet. We expect the future rate actions would be data dependent, and they will be watchful of evolving global & domestic environment. Given the current global as well as domestic indicators, we expect MPC to further moderate its rate hike to 25 bps in Feb 2023 to reach a policy rate of 6.5%. This may provide a safety cushion to absorb the global spillovers to an extent. India’s Foreign Exchange (FX) reserve has also improved over the last few weeks, which has also provided some relief.

Any further rate hikes beyond a policy rate of 6.5% would be more determined by global factors than domestic factors.

As the global and domestic rate hike cycle reaches towards the end over next few months, interest rate volatility is also expected to reduce compared to the heightened volatility witnessed over the past few months. At the same time, impact of future rate hikes has already been largely factored in specifically in the 2 – 5 years segment, while the long end may remain under pressure as the fiscal supply overhang is expected to continue for next year as well.

Credit environment remains healthy; however, current narrow spreads of AA / AA+ over AAA bonds do not provide favorable risk adjusted reward opportunities, and we expect il-liquidity premium to increase sharply over a period of time thereby posing mark to market challenges for this segment.