Chief Economist at the National Stock Exchange of India
It was a mere five months back that the world markets were celebrating a hat-trick of positive returns years, with major indices at life-time highs, having bested the worst of the Coronavirus pandemic, the US economy firing on all cylinders, and with the rest of the world following suit. The last five months have been a testimony to how things could go wrong even at the end of the tunnel. Runaway inflation breaching levels not seen in decades, finally made central banks sit up and take notice, including the RBI, on May 4th. Russia’s invasion of Ukraine in February, and the spread of virus in China were unforeseen events, as were the consequences. The Chinese lockdown of major urban centres exacerbated the impact on growth in the world’s second largest economy, while the failure to realise revanchist ambitions in Ukraine amplified the distortionary impact on several commodities, including those in the agricultural space. While incremental rate hikes are now a given, global markets continue to face the consequences of the increased political uncertainty in our world this year.
Global equities had a landslide fall in April at the steepest pace in the last two years, with no signs of respite in May (MSCI World Index: -8.4% (April), -5% (May till date), YTD -17.8%). Ongoing geopolitical tensions that refuse to ease, continued supply-chain disruptions, COVID-induced lockdown in China and rising interest rates have all weighed heavily on investor sentiments, notwithstanding visible economic ramifications of some of these issues. Emerging markets (DM) outperformed the broader developed market (DM) pack and fell by a little lower 5.7% in April and 3.8% in May thus far (YTD: -16%), reflecting the impact of pick-up in risk aversion globally.
Indian equities, while following suit, were relatively less impacted, reflecting the impact of strong buying by domestic institutional and retail investors, in turn providing some support amidst massive FII outflows. On the negative side, a sharp spike in recent inflation prints, expectations of more front-loaded rate hikes by RBI after the one delivered early this month and resultant surge in bond yields have added to investors’ caution. The Nifty 50 Index ended April with a loss of 2.1%, albeit much lower than its EM/DM counterparts, but is down 4.9% in May thus far (2022 YTD: -6.3%).
Sell-off in global debt continued in April as worsening inflationary concerns have increased expectations of aggressive rate hikes by the US Fed, leading to yields rising across the board. Markets, however, saw some respite in May after Fed’s Chair indication of 75bps hike being off the table for now. After a 30-50bps hike in May, sovereign bond yields in the US remained somewhat steady or inched down marginally across the curve in the current month. Indian fixed income market is finally catching up, with yields rising sharply over the last month or so following RBI’s surprise rate hike, overshooting the movement in global bond yields by a wide margin. The sell-off has been far more intense at the short-end, leading to significant flattening of the yield curve. Meanwhile, EM currencies have remained under pressure amid continued dollar strengthening, with INR falling 4.3% against the USD to record-high levels in 2022 till date.
On the macro front, inflation continued to rise and in an incrementally more broad-based manner, jumping to an eightyear high of 7.8% in April and surpassing the RBI’s upper bound for the fourth month in a row. This forced the RBI to go for an aggressive off-policy hike of 40 bps early this month, with expectations of more front-loaded hikes getting priced in. IIP growth at 1.9% in March was a tad higher than market expectations but provided dismal signs of recovery. Growth estimates are getting curtailed, with our estimate of 6.5% for FY23 being somewhat more sobering than the RBI’s 7.2% and the IMF’s 8.2%. Worsening global backdrop has increased India’s external vulnerability, as witnessed from widening trade deficit, flight of foreign capital away from Indian equities and depreciating rupee. Our estimates point to a huge deficit on the Balance of Payments this year following three good surplus years, even as our strong foreign exchange reserves position may provide some relief.
Our Story of the Month this time decodes states’ fiscal profile in the post-pandemic recovery phase by analysing budgets of 20 states that account for more than 90% of the country’s GDP. Our analysis shows that while states’ have been a tad more optimistic on the revenue front, they have generally been in sync with the Centre on pushing capital expenditure. That said, the quality of finances varies significantly across states, and understandably so, with Gujarat projecting the lowest 1.6% fisc. in FY23 and Madhya Pradesh the highest at 4.6%. States’ reliance on market loans to fund their deficits has increased manifold since 2015, more so during the pandemic, and remains an area of concern.
With ESG gaining significant prominence in India over the last few years, we started with the endeavour in the last edition of Market Pulse to touch upon important facets of an otherwise wide field of research.
As usual, the Insights section of the Market Pulse brings to the table summarised versions of research done on some though-provoking ideas in the field of financial markets. Insights from academic papers from the field of behavioural finance include the first featured paper by Nadine Strauss and Christopher Holmes Smith that shows that market reactions are driven by business events and expectations rather than the follow-up reporting by financial news media. The second highly cited paper from the same field by Ferri et al. experimentally investigates on implications that human Fast trading has on market outcomes. The section also features two highly cited papers from the field of general financial markets. The first one by Freyberger et al. proposes a non-parametric methodology to identify characteristics that provide incremental information on cross-sectional returns. The second by Dyck et al. examines whether institutional investors drive corporate social responsibility by providing international evidence.
We are now just one week away from the “Call for Papers” deadline for submission of research proposals under the NSE-NYU Stern Initiative. The last ten years have seen this initiative blossom into one of the top finance conferences in the country.
Times of stress necessitate focus on what is relevant, and a methodical approach, and the task is cut out for the next few months. Policy imperatives would be based on getting inflation under control with the lowest exit rate on rates without losing track of a nascent recovery, supporting the recovery with the optimal fiscal impulse despite tightening rates and managing the impact of an external environment that might stay turbulent in the near term.