The Nifty Index declined 2% in the month of February, which was its third consecutive month of decline, due to global macro challenges and a strong US economy, leading to market anticipating higher rates for an extended period, geopolitical tensions resurfacing, and volatility in listed stocks of a large Indian corporate group. Mid-cap and small-cap indices were down nearly 2% and 4%, respectively. Sector-wise, power (-16%), metals (-10%) and oil & gas (-9%) declined the most, while FMCG and capital goods were the only indices to close in green. FPIs continued on the selling trend, having sold US$ 647mn worth of Indian equities in the secondary market, while DIIs bought equities to the tune of $2.3bn.

3QFY23 earnings of India Inc. were subdued. High inflation, a rise in interest rates, and the resultant demand slowdown (in some consumption pockets) within the domestic market, as also as export-related challenges and currency volatility, weighed on earnings. Overall 3QFY23 earnings for Nifty 500 companies were up 6% yoy and 11.3% qoq. However, major earnings growth was attributed to BFSI companies, which logged robust earnings growth of 48% yoy and 3% qoq, contributing 42% of the overall earnings, while non-BFSI companies' earnings de-grew by 12% yoy indicating a slowdown.

Incoming data on high-frequency indicators remained largely steady in YoY terms, while on a sequential monthly basis it slowed a tad. GST collection for February (reflecting activity in January) came in at INR 1.49 trillion (vs. INR 1.56 trillion in January) growing by 12% YoY (vs. 10.6% in January). PMI manufacturing remained in the expansionary zone for the 20th consecutive month, remaining largely steady at 55.3 in February (vs. 55.4 in January). Services PMI rose to a 12-year high of 59.4 in February from 57.2 in January, led by favorable demand conditions and new business gains. Credit growth remained resilient at 16.1% YoY in February vs. 16.5% in January. Air passenger traffic rose on a sequential basis. The CMIE unemployment rate rose a tad to 7% in February.

With the post-Covid opening up/pent-up demand recovery in the economy largely behind us, India’s economic indicators may take a breather in 2023 as it too re-adjusts to slowing global growth. While India has undeniably had several false starts in the past, the conditions for a favourable investment cycle have never looked better. The confluence of stable balance sheets in each of the four vital pillars of any economy, namely households, corporates, banks and government, lends strong credence to this proposition. We believe, investment opportunities arising out of this fresh investment cycle will be far more rewarding than ever before. Even as consumption has been regarded as India’s mainstay, it will be the manufacturing and industrial economy of India that would surprise. The investment and capital expenditure push was the centrepiece of the recent budget too with capital investment outlay increased by 33%. This should further help infrastructure-oriented sectors and create multiplier effects that eventually feed into stronger consumption.

With near-term trends subdued and, as anticipated, in the absence of strong triggers for earnings upgrades near-term, India’s premium valuations have been coming off over the past few months. We expect this trend to extend for some more time into CY2023, opening important investment opportunities for medium-term investing for our investors. On our current reckoning, we expect the next earnings upgrade cycle in India to commence in mid-2024 as the impact of the global slowdown wanes and India’s structural growth drivers assert themselves more meaningfully. India remains one of the best ‘buy on dips’ markets for global investors focused on medium-term returns.

The Global backdrop turned challenging during the month, with many data points in the US like the jobs market, core inflation, & personal consumption expenditure pointing towards the need for higher policy rates and a delayed rate cut cycle than earlier expected. Various US FOMC members have also hinted towards a data-driven approach, making the next readings on inflation and jobs data very critical for rate trajectory. USD gained strength with expectations of tighter monetary policy. Global markets reacted negatively, with most of the developed nations witnessing a 40–50 bps rate hardening (10 yr G-Sec benchmark) with the shorter end coming under more pressure. Emerging nations also witnessed a hardening of rates, though to a lesser extent.

Domestically also, interest rates remained under pressure and G-Sec hardened by 15-30 bps across the curve, with the short end coming more under pressure rendering almost a flat yield curve. Corporate bonds also hardened, though to a lesser extent.

MPC moderated the rate hike to 25 bps to reach 6.5% as the repo policy rate but continued to maintain its “withdrawal of accommodation” stance. MPC’s more hawkish commentary on domestic inflation surprised the market negatively, thereby leaving the market guessing for the next policy action which was earlier positioned for 6.5% as the peak policy rate.

Headline CPI inflation in January surprised on the higher side with a 3-month high print of 6.5% y-o-y, sharply up from 5.7% in the previous month, led by both food at 6.2% YoY and core at 6.3% YoY. In sequential terms, the headline index rose by 1.1% m-o-m vs. 0.5% previously.

FPIs remained net equity sellers again in February, though marginally, a with an outflow of ~INR 54 bn. Debt segment saw a marginal inflow of ~INR 21 bn. Fx reserves at week ending 24th Feb were USD 561 bn, down USD 16 bn from end of Jan 2023. INR depreciated by ~0.9% during the month as the USD gained strength, but still remained relatively better as compared to other EM currencies.

Outlook

MPC’s hawkish commentary on inflation concerns and resilient domestic growth, the subsequent elevated inflation print, and the sharp change in the global backdrop have raised the probability of one more rate hike in the next meeting in April 2023 (from almost nil earlier). While the debate on the peak policy rate is still on, we believe MPC’s next policy action would be more data dependent and largely driven by the monetary policy action of other Global Central Banks especially the US FOMC. We also believe that India will see the policy rates remaining “Higher for Longer” as domestic growth-inflation dynamics may not provide any room for rate cuts in 2023, even if the Global Central Banks were to start their rate cuts in 2023 to address their country specific growth concerns.

As central banks reach to the peak policy rates over the next few months, markets have already factored in the next rate hikes to a large extent. With Central banks steering towards the end of the rate hike cycle and lesser uncertainty on fiscal supply for now, we believe the Indian fixed income market has come to an inflection point with risk-reward turning favourable for investors with already elevated yields, especially upto 5-year segment. Longer end may somewhat remain under pressure as the fiscal supply overhang continues for next year as well.

The 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 the illiquidity premium to increase sharply over a period of time, thereby posing mark to market challenges for this segment.