7 Dec 2023
Notwithstanding the recent weakening in the dollar, the global and Indian economy are at crossroads on many fronts. In this environment, we believe the RBI will opt to keep monetary policy tighter for longer, particularly in its upcoming 8 December meeting.
We expect the repo rate to be on hold at 6.5%, and for liquidity to remain tight with the call money rate trending higher than the repo rate. We also expect the stance to remain unchanged i.e. “withdrawal of accommodation” given liquidity remains tight. The RBI may focus more on tweaking macro prudential norms, to address some excesses in the system. It has already raised risk weights on certain lending.
We see many reasons for a continuation of tight monetary policy:
Changing flows. India is at a crossroads on various fronts. Portfolio inflows are exhibiting renewed momentum, but FDI inflows have fallen sharply. India may be at an interesting crossroads, where pandemic-led FDI flows in sectors like computer services, drugs, and pharmaceuticals have slowed, but investment intentions reveal meaningful interest in futuristic sectors like renewables, semiconductors, and AI. But until these flows come to fruition, the RBI may be sensitive to a falling balance-of-payment surplus and its impact on the currency, thereby keeping monetary policy tight.
Evolving inflation. In good news, core inflation has finally started falling after a long wait, but food inflation remains uncertain in an El Niño year. Reservoir levels are low, and a recent vegetable price spike means that the next two inflation readings could be close to 6% (from 4.9% in October), before moderating on the back of the winter vegetable disinflation. But where it rests then will depend a lot on the winter wheat crop, and that may not be clear until March. Until then, the RBI may want to err on the side of caution in its treatment of rates.
Glorious growth. The GDP growth momentum is strong as evidenced by the 7.6% growth clip of the September quarter. We believe that even though growth could slow by c150bp from 1H to 2HFY24, the majority of that would be led by statistical reasons. Actual growth may not soften much, leaving the RBI on its toes.
We believe the RBI will continue to maintain tight monetary policy at its 8 December meeting. We see many reasons for this, which we discuss below.
India’s global footprint is deepening. It is not just that its GDP growth is rising sharply, but its share of global goods and services exports has risen. After turning negative for a few months, equity inflows shot back up in November (at USD1.1bn). Inflows into the debt market have also become buoyant (USD1.8bn in November), especially after the JP Morgan Index Inclusion announcement.
All of this stands at odds with the fall in India’s FDI inflows. On a year-to-date basis, FDI inflows have fallen to USD4.5bn this year vs USD19.6bn last year (Chart 1). India’s share in global FDI has also fallen. All of this, alongside a rising current account deficit, may push the balance-of-payments into deficit (Chart 2).
We looked closely and found that FDI inflows may be at a crossroads. One – the pandemic-led demand for some goods and services like drugs and pharmaceuticals, and computer services led by rising work-from-home, may have softened. No surprise then that FDI inflows in these sectors have also slowed (Chart 3). Two – as per some metrics, China has become a net direct overseas investor since early 2023. Its investments are spreading across continents – ASEAN, the Middle East, Europe and Latin America. But not much in India. In fact, we think India’s FDI is at a crossroads as sectors in the spotlight are changing, as are the providers of FDI.
And yet, India’s FDI outlook remains positive. The investment intention data we track continues to rise. It is also becoming more diversified across various sectors. Even if India is not getting certain country-led flows– as per investment intentions – it could get compensated for by other country-led flows in newer sectors. For instance, Abu Dhabi announced a renewable energy USD30bn fund on 1 December, and listed India as a key market.
But while India stands at the FDI crossroads (with pandemic focused sectors receding and futuristic sectors rising), the RBI may be sensitive to the balance-of-payments and its impact on the currency, keeping monetary policy tight.
In good news, after staying elevated for an extended period, core inflation has come down to sub-5% levels across the various definitions (Chart 5), and the diffusion index shows that only 50% of the core items have inflation of more than 4%.
Having said this, we need to watch the decline in core inflation closely as it has come even before the economy has slowed. The natural direction of travel is rate hikes slowing the economy, which in turn slows inflation. Also the housing index data in the CPI basket is not meeting the smell test. Anecdotal evidence points to rising house prices and rentals, but housing inflation has been at the pre-pandemic level of 4.5% y-o-y.
And food inflation pressures are too widespread to ignore. In November, 50% of food items saw higher inflation than in October. These include cereal, pulses, vegetables, fruits, sugar, and spices.
Reservoir levels are low and cereal stocks, too, are at low levels (Charts 6 and 7). Cereals matter. Given its importance in the food basket (having a weight of c20%), we find that once it rises, it remains elevated for a few quarters, and even spills over into core inflation (Chart 8).
Given the price spike in some vegetables in November1, the next two inflation readings are likely to be around 6%, before moderating on the back of winter disinflation. But where it rests then will depend a lot on the winter wheat crop, and this will only become clear in March.
Until then, the RBI may want to err at the side of caution in its treatment of rates.
The September quarter GDP growth came in at a higher-than-expected 7.6%, signifying the strong growth momentum in the economy.
Sure, there were sectoral divergences. For instance, urban demand zipped ahead while rural slowed (Chart 10). Industry and manufacturing outpaced services (Chart 11), while investment outpaced consumption.
Then, there was the case of statistical exaggeration of numbers because of the practice of single deflation instead of double deflation, which tends to exaggerate growth in times of falling commodity prices; something we have been writing about for a while. We also believe there were low base effects coming from the pandemic period, which led to high GDP numbers in 1H, but would dissipate in 2H (Charts 12 and 13).
And falling FDI (even if temporarily), a weakening agricultural sector, and any softness in credit growth could, over time, lower the growth momentum.
But because the momentum is so strong, we do not expect growth to slow sharply. Government capex could fall, but some of it may help create space for current expenditure. Credit growth could ease, but may not fall sharply given structural improvements in access. FDI has fallen, but could get compensated, to some extent, by other flows.
We believe that even though growth could fall by c150bp from 1H to 2H, about 100bp out of that would be led by statistical reasons, for instance the y-o-y fall in commodity prices lowering and the low base effects normalising.
Actual growth may not soften much, leaving the RBI on its toes.
Of the four state election results that were announced on 3 December, the BJP won three –Madhya Pradesh, Rajasthan, and Chhattisgarh – with a showing that was better than expected. These three states make up an important part of the Hindu heartland. The Indian National Congress party won the fourth state, i.e. the southern state of Telangana.
While the state elections do not give a perfect indication of what can happen in the national elections in May 2024, markets may interpret it as an indication that the BJP has a good chance of winning the national elections as well, paving the way for Prime Minister Modi to return as India’s Prime Minister for a third term. More perceived certainty on the results may lower the risk premium on asset prices going into the national election year.
The RBI has been gradually broadening its toolkit – from raising rates, to tightening liquidity, and finally to strengthening macro prudential norms – in its efforts to maintain macroeconomic stability at a time of global volatility.
Macro prudential norms – on 16 November, the RBI announced higher risk weights for unsecured consumer credit, as well as bank lending to NBFCs, to temper the rapid growth in this sector, which had touched a growth clip which was 4-times nominal GDP growth. We believe the RBI will be tracking the data to determine if further action is needed. In the meantime, the RBI would also look at other areas that may require some degree of intervention, for instance hedging activity by corporates, (which may have fallen at a time of INR stability vis-a-vis the dollar).
Important disclosures
Additional disclosures
1. This report is dated as at 05 December 2023.
2. All market data included in this report are dated as at close 04 December 2023, unless a different date and/or a specific time of day is indicated in the report.
3. HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking, Principal Trading, and Research businesses toensure that any confidential and/or price sensitive information is handled in an appropriate manner.
4. You are not permitted to use, for reference, any data in this document for the purpose of (i) determining the interest payable, or other sums due, under loan agreements or under other financial contracts or instruments, (ii) determining the price at which a financial instrument may be bought or sold or traded or redeemed, or the value of a financial instrument, and/or (iii) measuring the performance of afinancial instrument or of an investment fund.
This document or video is prepared by The Hongkong and Shanghai Banking Corporation Limited (‘HBAP’), 1 Queen’s Road Central, Hong Kong. HBAP is incorporated in Hong Kong and is part of the HSBC Group. This document or video is distributed and/or made available, HSBC Bank (China) Company Limited, HSBC Bank (Singapore) Limited, HSBC Bank Middle East Limited (UAE), HSBC UK Bank Plc, HSBC Bank Malaysia Berhad (198401015221 (127776-V))/HSBC Amanah Malaysia Berhad (20080100642 1 (807705-X)), HSBC Bank (Taiwan) Limited, HSBC Bank plc, Jersey Branch, HSBC Bank plc, Guernsey Branch, HSBC Bank plc in the Isle of Man, HSBC Continental Europe, Greece, The Hongkong and Shanghai Banking Corporation Limited, India (HSBC India), HSBC Bank (Vietnam) Limited, PT Bank HSBC Indonesia (HBID), HSBC Bank (Uruguay) S.A. (HSBC Uruguay is authorised and oversought by Banco Central del Uruguay), HBAP Sri Lanka Branch, The Hongkong and Shanghai Banking Corporation Limited – Philippine Branch, HSBC Investment and Insurance Brokerage, Philippines Inc, and HSBC FinTech Services (Shanghai) Company Limited and HSBC Mexico, S.A. Multiple Banking Institution HSBC Financial Group (collectively, the “Distributors”) to their respective clients. This document or video is for general circulation and information purposes only.
The contents of this document or video may not be reproduced or further distributed to any person or entity, whether in whole or in part, for any purpose. This document or video must not be distributed in any jurisdiction where its distribution is unlawful. All non-authorised reproduction or use of this document or video will be the responsibility of the user and may lead to legal proceedings. The material contained in this document or video is for general information purposes only and does not constitute investment research or advice or a recommendation to buy or sell investments. Some of the statements contained in this document or video may be considered forward looking statements which provide current expectations or forecasts of future events. Such forward looking statements are not guarantees of future performance or events and involve risks and uncertainties. Actual results may differ materially from those described in such forward-looking statements as a result of various factors. HBAP and the Distributors do not undertake any obligation to update the forward-looking statements contained herein, or to update the reasons why actual results could differ from those projected in the forward-looking statements. This document or video has no contractual value and is not by any means intended as a solicitation, nor a recommendation for the purchase or sale of any financial instrument in any jurisdiction in which such an offer is not lawful. The views and opinions expressed are based on the HSBC Global Investment Committee at the time of preparation and are subject to change at any time. These views may not necessarily indicate HSBC Asset Management‘s current portfolios’ composition. Individual portfolios managed by HSBC Asset Management primarily reflect individual clients’ objectives, risk preferences, time horizon, and market liquidity.
The value of investments and the income from them can go down as well as up and investors may not get back the amount originally invested. Past performance contained in this document or video is not a reliable indicator of future performance whilst any forecasts, projections and simulations contained herein should not be relied upon as an indication of future results. Where overseas investments are held the rate of currency exchange may cause the value of such investments to go down as well as up. Investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in some established markets. Economies in emerging markets generally are heavily dependent upon international trade and, accordingly, have been and may continue to be affected adversely by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. These economies also have been and may continue to be affected adversely by economic conditions in the countries in which they trade. Investments are subject to market risks, read all investment related documents carefully.
This document or video provides a high-level overview of the recent economic environment and has been prepared for information purposes only. The views presented are those of HBAP and are based on HBAP’s global views and may not necessarily align with the Distributors’ local views. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. It is not intended to provide and should not be relied on for accounting, legal or tax advice. Before you make any investment decision, you may wish to consult an independent financial adviser. In the event that you choose not to seek advice from a financial adviser, you should carefully consider whether the investment product is suitable for you. You are advised to obtain appropriate professional advice where necessary.
The accuracy and/or completeness of any third-party information obtained from sources which we believe to be reliable might have not been independently verified, hence Customer must seek from several sources prior to making investment decision.
The following statement is only applicable to HSBC Mexico, S.A. Multiple Banking Institution HSBC Financial Group with regard to how the publication is distributed to its customers: This publication is distributed by Wealth Insights of HSBC México, and its objective is for informational purposes only and should not be interpreted as an offer or invitation to buy or sell any security related to financial instruments, investments or other financial product. This communication is not intended to contain an exhaustive description of the considerations that may be important in making a decision to make any change and/or modification to any product, and what is contained or reflected in this report does not constitute, and is not intended to constitute, nor should it be construed as advice, investment advice or a recommendation, offer or solicitation to buy or sell any service, product, security, merchandise, currency or any other asset.
Receiving parties should not consider this document as a substitute for their own judgment. The past performance of the securities or financial instruments mentioned herein is not necessarily indicative of future results. All information, as well as prices indicated, are subject to change without prior notice; Wealth Insights of HSBC Mexico is not obliged to update or keep it current or to give any notification in the event that the information presented here undergoes any update or change. The securities and investment products described herein may not be suitable for sale in all jurisdictions or may not be suitable for some categories of investors.
The information contained in this communication is derived from a variety of sources deemed reliable; however, its accuracy or completeness cannot be guaranteed. HSBC México will not be responsible for any loss or damage of any kind that may arise from transmission errors, inaccuracies, omissions, changes in market factors or conditions, or any other circumstance beyond the control of HSBC. Different HSBC legal entities may carry out distribution of Wealth Insights internationally in accordance with local regulatory requirements.
Important Information about the Hongkong and Shanghai Banking Corporation Limited, India (“HSBC India”)
HSBC India is a branch of The Hongkong and Shanghai Banking Corporation Limited. HSBC India is a distributor of mutual funds and referrer of investment products from third party entities registered and regulated in India. HSBC India does not distribute investment products to those persons who are either the citizens or residents of United States of America (USA), Canada, Australia or New Zealand or any other jurisdiction where such distribution would be contrary to law or regulation.
The following statement is only applicable to HSBC Bank (Taiwan) Limited with regard to how the publication is distributed to its customers: HSBC Bank (Taiwan) Limited (“the Bank”) shall fulfill the fiduciary duty act as a reasonable person once in exercising offering/conducting ordinary care in offering trust services/ business. However, the Bank disclaims any guarantee on the management or operation performance of the trust business.
The following statement is only applicable to PT Bank HSBC Indonesia (“HBID”): PT Bank HSBC Indonesia (“HBID”) is licensed and supervised by Indonesia Financial Services Authority (“OJK”). Customer must understand that historical performance does not guarantee future performance. Investment product that are offered in HBID is third party products, HBID is a selling agent for third party product such as Mutual Fund and Bonds. HBID and HSBC Group (HSBC Holdings Plc and its subsidiaries and associates company or any of its branches) does not guarantee the underlying investment, principal or return on customer investment. Investment in Mutual Funds and Bonds is not covered by the deposit insurance program of the Indonesian Deposit Insurance Corporation (LPS).
Important information on ESG and sustainable investing
In broad terms “ESG and sustainable investing” products include investment approaches or instruments which consider environmental, social, governance and/or other sustainability factors to varying degrees. Certain instruments we classify as sustainable may be in the process of changing to deliver sustainability outcomes. There is no guarantee that ESG and Sustainable investing products will produce returns similar to those which don’t consider these factors. ESG and Sustainable investing products may diverge from traditional market benchmarks. In addition, there is no standard definition of, or measurement criteria for, ESG and Sustainable investing or the impact of ESG and Sustainable investing products. ESG and Sustainable investing and related impact measurement criteria are (a) highly subjective and (b) may vary significantly across and within sectors.
HSBC may rely on measurement criteria devised and reported by third party providers or issuers. HSBC does not always conduct its own specific due diligence in relation to measurement criteria. There is no guarantee: (a) that the nature of the ESG / sustainability impact or measurement criteria of an investment will be aligned with any particular investor’s sustainability goals; or (b) that the stated level or target level of ESG / sustainability impact will be achieved. ESG and Sustainable investing is an evolving area and new regulations are being developed which will affect how investments can be categorised or labelled. An investment which is considered to fulfil sustainable criteria today may not meet those criteria at some point in the future.
THE CONTENTS OF THIS DOCUMENT OR VIDEO HAVE NOT BEEN REVIEWED BY ANY REGULATORY AUTHORITY IN HONG KONG OR ANY OTHER JURISDICTION. YOU ARE ADVISED TO EXERCISE CAUTION IN RELATION TO THE INVESTMENT AND THIS DOCUMENT OR VIDEO. IF YOU ARE IN DOUBT ABOUT ANY OF THE CONTENTS OF THIS DOCUMENT OR VIDEO, YOU SHOULD OBTAIN INDEPENDENT PROFESSIONAL ADVICE.
© Copyright 2024. The Hongkong and Shanghai Banking Corporation Limited, ALL RIGHTS RESERVED.
No part of this document or video may be reproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of The Hongkong and Shanghai Banking Corporation Limited.
