Indian markets ended the month on a weak note amidst global concerns over a new coronavirus variant. The BSE-30 and Nifty-50 fell nearly 4% each, their biggest monthly loss since March 2020. This was caused by several factors ranging from a global risk-off driven by accelerated taper worries / Omicron concerns to disappointing listing of India’s largest IPO. A sharp rally in Dollar index too weighed on the Emerging Market complex, including India which continued to witness FII outflows. Ahead of the crucial state elections in UP and Punjab early next year, PM Modi announced the decision to repeal the 3 contentious farm laws as farmer unions continued to oppose them despite several round of talks. Covid cases during the month in India remained under control (daily sub-15k) and the pace of vaccination remains healthy with India having so far administered over 1.22bn vaccine doses wherein ~55% of the population has received the first dose while ~32% of the population has been fully vaccinated.

High-frequency data showed a mixed trend with some indicators slowing sequentially reflecting the impact of festival-related holidays. GST collections in November rose to INR1.32tn with 2Y CAGR moderating to 12.9% in November from 16.7% in October. PMI manufacturing rose to 57.6 in November, highest since February-2021. Credit growth is showing nascent signs of recovery, with growth improving to 7% YoY in November from 6.8% in October. E-way bills, power demand and rail freight slowed in sequential and 2Y CAGR terms reflecting the impact of festival-related holidays impacting production days.Services PMI remained largely steady at 58.1 in November vs. an all-time high of 58.4 in October. Mobility indicators (ex - residential) remained steadily in the positive zone. Air passenger traffic for November rose sequentially by 24% and is tracking at 124% of February-2021 levels. On the corporate earnings front, 2QFY22 Nifty sales/EBITDA growth were largely in-line at 31%/21% YoY, while PBT/PAT growth came in at 40%/36% YoY. Among the Nifty constituents Ex-Metals and O&G, Nifty profits posted 13% YoY growth which was broadly in line with consensus estimates.

Globally, inflation remained the most important point of debate and concern for the markets followed by Omicron. The strong 6.2% inflation print in the US for the month of October triggered alarm bells politically and forced the US Fed to harden its stance on inflation, to begin treating it as more enduring than before, and also signal faster normalization of the monetary unwind announced last month. This has also led markets to wager on the possibility of interest rate hikes too being brought forward by the Fed towards the end of CY2022. On Omicron, many govts worldwide have swung into precautionary action (travel bans imposed by more than 20 countries) which perhaps is an understandable and predictable response to the emergence of what is regarded as a highly infectious Covid variant. So far it appears that Omicron is far more infectious than it is deadly. Yet, it will be a few weeks before the efficacy of existing vaccines against it will have been established and markets may display intermittent volatility until then. Though we believe markets are unlikely to fall as much as in early 2020, the recent strong gains in cyclical assets suggest that there is room for a decent correction.

At the margin however, the cool-off in recent weeks in commodity prices, freight rates, oil prices etc will likely soothe global inflation trends. We maintain that long-term inflation trends are fundamentally the result of excess money growth and elevated inflation will likely persist in our view, in countries that have seen sharp monetary growth in this period. In India too, we cannot rule out imported inflation feeding through into local inflation (for e.g. fuel prices) though offsets in soft commodity and food prices will likely ensure that India’s headline inflation remains within RBI’s stated comfort band thereby implying no material change in stance to its monetary and interest rate policy in the near-term. India’s strong FX reserves too provide the comfort against reversal of capital flows due to higher interest rates elsewhere around the world. Meanwhile, liquidity reduction measures by global central banks can also lead to a retreat of inflation. Meanwhile, we also move with the belief that peak inflation in this round of global growth will likely be lower than seen in earlier cyclical upswings.

Market risk-reward appears evenly balanced at this stage. We continue with our view that the Indian economy should build on its recovery even beyond 2021. A potential 3rd wave may slow down activity levels but increasing vaccination levels provides comfort against large-scale economic dislocations and pressures on health infrastructure of the type seen in the past. We continue with our pro-cyclical stance with investments in sectors like financials, industrials, consumer discretionary. We remain invested in technology and healthcare as well but have moderated our positions due to sharp run-up in the space off late. Our chosen path to portfolio construction is a measured approach with respect to sector exposure, market cap bias and the balance between growth and value. In general, our portfolios continue to be positioned for better risk-adjusted return outcomes over a 3-5-year period.

India is well-positioned to commence on a new economic upcycle over the next few years which can mean broad-based improvement across a variety of industries. This offers equity investors an opportunity to benefit over the medium to long term. We recommend investors use market volatility to their advantage in increasing their long-term equity commitments, while keeping return expectations moderate and maintaining a sharp focus on risk control.

Domestic demand and activity levels continued the strong rise in November. Services sector showed good momentum on back of better mobility and festive period whereas the manufacturing sector continues to be well positioned given strong domestic demand. Input price pressures are being which will likely keep core inflation high. Foreign exchange reserves continue to remain strong giving protection from external spillovers. With the pace and scale of Covid-19 vaccination continuing to improve, growth should continue to remain strong for rest of the fiscal year.

India's real gross domestic product (GDP) grew by 8.4% y-o-y in the quarter ended September 2021. GDP has now recovered completely from the -7.4% contraction it had suffered in the September quarter last year.

Output of eight core industries increased in October 2021 by 7.5% y-o-y vs. 4.5% in September driven by double digit growth in coal, natural gas, refinery products and cement. Lower base also aided growth.

Manufacturing PMI rose to 57.6 in November 2021 from 55.9 in October 2021. This is the fifth consecutive month when the index has been in an expansionary mode. November saw an accelerated rise in sales which led to the fastest upturn in production in the last nine months. Inventory re-stocking was the highest in the last 17 years.

Service PMI for November 2021 stood at 58.1, a shade weaker than its October 2021 reading of 58.4. Nonetheless, the index remained in an expansionary mode for the fourth consecutive month.

CPI inched up 4.48% y-o-y in October compared with 4.35% y-o-y in September. Food inflation increased to 0.85% y-o-y led by vegetable prices which rose by 14.2% m-o-m. Many other food items too saw monthly uptick. Core inflation (excluding food and fuel) remained elevated at 6.17% y-o-y vs. 5.86% in September. The pass-through of higher international oil prices into domestic retail prices has been an important driver of core inflation.

Purchase price inflation, which had scaled an all-time high in October 2021, remained almost unchanged in November 2021, owing to high transportation costs and demand-supply mismatch.

On the trade front, India’s trade deficit hit a monthly all-time high of USD 23.3 bn on back of 57.2% y-o-y increase in imports vs a 26.5% y-o-y increase in exports.

After touching all-time monthly high figure in October, exports fell sharply on sequential basis by 15.6% m-o-m to USD 29bn. Over a 2 two-year period, exports are higher by 15.9%. During April-November 2021, exports are now at USD 262.5bn, an increase of 50.7% over last year and 24.3% over April-November 2019.

Imports moderated slightly on a sequential basis to USD 53.2bn, lower by 4.4% m-o-m led by decline in gold and non-oil-non-gold imports. Oil imports increased 1.7% m-o-m on back of robust demand and higher oil prices. April-November 2021, oil import bill has surpassed USD 100bn compared with USD 44.3bn in same period last year and USD 86bn in April-November 2019.

MPC in its December 2021 policy review decided to continue with its growth supportive stance by keeping policy rates unchanged and maintaining accommodative stance, for the ninth consecutive policy review. The market was surprised by RBI maintaining the LAF corridor at 65 basis by keeping the reverse repo unchanged at 3.35% (was expected to be raised by 20-25 basis) and repo at 4% (no change was expected).Overall, the policy continues to focus on durable and broad-based growth recovery coupled with the effective liquidity management. With uncertainties arising from the surge in Covid-19 infections in many parts of the world and emergence of Omicron variant, MPC chose to support growth and maintain accommodative stance.

Outlook

Domestically also, RBI is midway of a gradual policy normalization with more steps towards liquidity re-calibration vide Variable rate auctions (most of the liquidity) vs fixed rate reverse repo which was the earlier focus. This will be followed by restoring of the policy rate corridor back to 25 bps (as before the pandemic) likely by early next year.

As inflation remains within MPC’s medium-term target, we believe the direction is – repo rate lower for longer

On the international front - one part of the world believes that we are in a Greenflation Supercycle (green climate and transitions leading to lower supply vs increasing demand causing Commodity prices to rise sharply) and the other believes that sustainable growth is a struggle for the globe post 2008 and therefore commodity prices cannot go up one way and will correct.

Against the backdrop of gradual normalization of policy rate corridor and international commodity price uncertainty, we feel that up to 6 months segment of the yield curve is apt for risk-averse investors. For investors looking at the core allocation of their portfolio, the 2-5 years segment of the yield curve remains attractively placed from carry perspective given the current steepness of the curve. Additionally, recent hardening of interest rates, benign liquidity conditions and favorable demand-supply dynamics also augers well for this segment. This segment is neither too short to be adversely impacted by low yields nor too long to be exposed to high interest rate volatility amidst global uncertainty. Investors with long term horizon & ability to absorb short term volatility may consider longer-end of the curve as a tactical allocation which finds merit on the back of conviction that RBI will manage the yield curve and may support the long-term yields through the tools like Open Market Purchase operations & Operation Twist. Possible inclusion of Indian G-Sec in global bond indices will also provide positive backdrop to the long end of the yield curve.

While the credit environment is expected to improve over the medium term, we believe credit dispersion will continue as of now and one must be cautious when getting onto the credit side. Selective AA / AA+ rated credits backed by strong conviction of improvement on their credit metrics may provide favorable risk-reward opportunities.