The BSE-30 and Nifty-50 gained 4% each in March while Mid-cap and small-cap indices were up 5% and 6% on optimism about progress in Ukraine-Russia peace talks. On the global monetary policy front, Federal Reserve raised rates by 25 bps, BoE raised its key policy rate by 0.25%, BoJ and ECB maintained status quo on rates. FII selling continued in the Indian stock markets, to the tune of -$5.4 bn in March while DII buying provided strong support to the markets. Among sectoral indices, IT, oil & gas and metals were up 9%, 8% and 8% respectively, while auto and consumer durables ended lower, falling 2% each. Other key developments during the month was BJP winning four out of five states in the recently concluded assembly elections, which reflects strong to the ruling party.

High-frequency data for March recorded improvement from February levels. While some high-frequency industrial activity indicators remained robust, others slowed down marginally. GST collection in Mar (reflecting activity in Feb) rose to an all-time high of INR 1.42tn, even though YoY growth moderated to 14.6%YoY in Mar from 17.6% in Feb. PMI manufacturing continued to expand as it touched 54 in Mar from 54.9 in Feb, albeit the slowest since Oct-21. Power demand rose 5.9%YoY, its highest in seven months. Rail freight and credit growth moderated on YoY basis. Mobility indicators (ex-residential) reached record highs with economic activity continuing to normalize. Air passenger traffic clocked 24.9% growth on a sequential basis in Mar. CMIE's unemployment rate, improved to 7.6% in Mar from 8.1% in Feb. Exports rose to an all-time high of US$40.4bn for Mar and crossed the US$400bn mark in FY2022.

At an aggregate level, the recovery in the local market during March has been surprisingly quick and fairly broad-based, partly reflecting expectations of the conflict being transient besides the cool-off in many commodity prices during the month providing additional relief. Indian equities will likely continue to derive confidence on three main planks: 1) With inflation in an economy at a point in time being more co-related to money supply trends of the recent past, India’s inflation trajectory may not be as daunting in the near-term despite high oil and may be well short of its previous peak. 2) Post pandemic at an aggregate level we see India’s starting point in terms of strength of corporate/banking sector, households and govt balance sheets to be in reasonable shape to withstand external shocks and 3) the continuing benign trends of Covid in India since the start of CY22. India however needs broad basing of its post-pandemic recovery across the income and enterprise spectrum for current valuations to sustain.

What the Russia-Ukraine conflict has clearly brought to the fore is the meaningful under-investment at a global level in traditional hard commodities and that may have to change course in the coming years. This will likely throw up specific long term investment opportunities but tactically necessitate a more balanced distribution in the near-term on portfolio exposures to producers and consumers of commodities until geo-political risks subside. From a medium-term perspective the current situation also throws up contrarian opportunities in specific pockets where excessive pessimism is visible such as autos/industrials, parts of consumer discretionary and domestic commodities like cement.

Over the coming months, equity markets will be razor-focused on potential changes to earnings expectations especially in commodity-sensitive sectors and possibly brace for any indication of downgrades. Post the recovery in March, markets have once again regained their somewhat premium valuations. The volatility seen since the start of 2022 may well continue as markets adjust to normalizing of central bank’s policies, geo-politics and commodity prices. We retain our view that India will likely witness a better economic cycle over the next 3-5 years vs the prior 5-years; accordingly, we overweigh financials, consumer discretionary and industrials. We recommend investors use current market volatility to their advantage in increasing their long-term equity commitments and benefit from the healthy earnings growth cycle expected to unfold over the next 2-3 years, while keeping return expectations moderate and maintaining a sharp focus on risk control.

Domestic economy gathered momentum buoyed by the relaxation of Covid-19 restrictions but moderated by sharp rise in inflationary pressures. March saw many critical events like unprecedented volatility in global commodity markets on back of Russia-Ukraine conflict hurting the global growth and also US Federal Reserve Bank first rate hike of 25 bps after more than three years. Covid-19 led disruptions are behind us, nonetheless RBI has moderated the projected real GDP growth rate for FY23 from 7.8% to 7.2% factoring in the global developments.

February headline CPI inflation picked up again to 6.07% y-o-y compared with 6.01% y-o-y in January, led by broad-based 0.2% sequential increase & remained above the RBI’s upper threshold for 2nd consecutive month. Core inflation (excluding food and fuel) was stable at 6% y-o-y. The backdrop of higher international food, oil and industrial metal prices implies upside risk to inflation outcomes in the coming months and factoring in surge in global commodity prices, RBI has sharply increased the FY23 average inflation projections from 4.5% to 5.7%.

For the full FY22 – exports, imports and trade deficit reached all time highs. FY2022 trade deficit was at US$192.4 bn compared to US$102.6 bn in FY2021 which can lead to CAD / GDP at ~1.5% in FY22. With uncertainties arising from geo-political risks and higher global commodity prices especially crude, FY23 trade deficit / CAD is expected to widen further.

FPI’s sold off sharply in both debt (~INR 57bn) as well as equity (~INR 371bn) amidst global risk-off sentiment triggered by geo-political risks. FX reserves were lower by USD 14 bn at approximately USD 617.6 bn. INR remained volatile during the month and oscillated between INR 75.71 to 76.97 against USD, as EM currencies came under pressure even as RBI’s intervention smoothened the impact to some extent.

MPC maintained status quo on policy rates, as widely expected. However, with Covid-19 led disruption behind us and still evolving global war situation, MPC has clearly administered a pivotal shift from a non-conventional growth supportive approach to a more conventional data driven inflation targeting framework and has indicated the order of priority as inflation – growth – financial stability, which upto Feb 2022 used to be “growth recovery on sustainable basis and mitigating impact of Covid-19 took precedence over inflation”. MPC has reiterated that its forward guidance on policy signals a shift away from ultra-accommodation adopted during pandemic.

Interest rates remained volatile during the month on the back of many key events – worsening of geo-political risks, US FED rate hike, flare up in global commodities and global rate volatility. During the month, the rate curve moved upwards by 5-10 bps in a parallel move with marginal steepening. 10 year benchmark G-Sec hardened by ~7 bps during the month to close at 6.84% on month end, which also got supported to an extent due to no fresh g-sec auction during the month.

Outlook

Global backdrop has worsened further on account of faster tightening of global monetary policies, worsening of Geo-political risks and surge in commodity prices which it is expected to pose bigger challenges for Indian fixed income market. Another critical factor of huge government borrowings in FY23 also remains negative and can worsen amidst global risk-off. While RBI continues to reassure the completion of G-Sec borrowing in a non-disruptive way, a concrete action in terms of G-Sec purchase will be awaited.

With recent MPC policy explicitly articulating its forward guidance on rate policy and with the current state, we expect MPC to change its accommodative stance to Neutral in next June MPC policy and begin with a gradual rate hike cycle beginning August policy onwards. While the policy actions are expected to be more data driven, without factoring in any tail risk on inflation-growth dynamics, we continue to believe that RBI will undertake ~50 bps rate hike in the 2nd half of CY2022 which is more than factored in already by the market. Having said that, with the pivotal shift of MPC to inflation control, any negative surprise on inflation front can prompt MPC to go for more aggressive rate hikes even at an expense of growth impact, something we don’t expect as of now.

Year 2022 is expected to remain volatile for domestic rates with an upward bias as two factors continuing to pose challenges (global backdrop & fiscal supply) and the third factor (RBI) which so far had remained supportive with growth oriented accommodative stance, gradually turning neutral. Against this backdrop we believe that gradual policy rate hikes by RBI & already steep yield curve provides investment opportunity in the short end of the curve.

We feel that 6 months to 1 year segment of the yield curve provides opportunity to risk-averse Investors. For investors looking at the core allocation, the 1 to 3 year segment of the yield curve remains well placed from carry perspective, given the current steepness of yield curve. To us, it is a sweet spot on the yield curve – neither too short which gets impacted by low gross yields, nor too long that can get impacted by the rate volatility.

Credit environment is expected to continue improving over the medium term. However, current extremely narrow spreads of AA / AA+ over AAA bonds do not provide favorable risk adjusted reward opportunities and we expect illiquidity premium of AA / AA+ segment to increase sharply over a period of time thereby posing mark to market challenges.