Blue Lake Finserve

07/12/2022

RBI increased Repo rate by 0.35% in its monetary policy decision today with continuing stance of withdrawal of accommodation.

Inflation projection for FY23 has been retained at 6.70% but GDP growth projection was further lowered to 6.80% from 7.00% in September 2022 policy (and 7.20% earlier).

RBI emphasized on growth in India being resilient amidst global slowdown and Current Account Deficit manageable. Governor also mentions that peak of inflation is behind us but war on inflation will need to continue. RBI is additionally observing Core inflation which is getting sticky around 6% and may not come down as fast as headline CPI with continuing input price passthrough and services inflation rising.

With this background, we can expect another 0.25% hike in the next policy in February 2023 to keep inflation expectations under check. More importantly, higher rates may remain longer in India as well.

How does this impact our investment decisions?

Debt market will continue to be a good investment option considering risk return matrix. Equity market remains less attractive in short term with forward PE of 20x for equity, but long term attractiveness of Indian equity is simply undeniable. Hence, staggered equity allocation would remain our choice.

14/11/2022

India Retail Inflation (CPI) for October 2022 has come out sharply down to 6.77% from 7.41% in September. This is not far from the Q3 CPI projection of 6.5% given by RBI in it’s September policy.

Additionally, WPI in October has dropped to 8.39% from 10.79% in September. This is 19 month low WPI print and in single digit for the first time since March 2021.
Both these figures indicate that inflation in India is coming down in orderly fashion as forecasted by RBI.

With inflation clearly peaking and now on downward trajectory, it is reasonable to expect that interest rate in India have peaked. If the trajectory continue, Repo rate peak may be lower than 6.50% which has been market expectation after last policy.

This is a good news for long duration fixed income investment which we have been adding in our portfolios.

13/10/2022

30/09/2022

RBI increased Repo rate by 0.50% in it’s monetary policy decision today. Inflation projection at 6.70% was retained but GDP growth projection was lowered to 7.00% from 7.20% earlier for the current financial year.

With policy rate at 5.9% and projected inflation at 5% in first quarter of next FY, future rate hikes required for inflation control may be lower. On the other hand, more hikes may be required to protect USDINR levels.

Yield curve already prices in terminal Repo rate of close to 6.50% which largely factors future interest rate hikes. With monetary policy event gone and yield curve remaining stable, I continue to believe debt remains very attractive asset class compared to equity.

Equity may continue to remain under pressure for near future with more downside risks than potential returns. These potential downside may come from global recession, re-rating of Indian Equity by FPIs and hence potential FPI outflows, slower growth in earnings.

20/09/2022

Focus back to Fed and RBI

Federal Reserve is expected to increase Fed rate by another 0.75% with some players expecting 1.00% as well. Latter may provide a shock therapy to US as well as global risk markets. On the other hand, RBI is expected to hike Repo rate by 0.35%-0.50%.

Inflation in US and Europe remains astonishingly high. But for India, inflation worry is likely to subside sooner than rest of the world. Even now inflation in India is modestly high by historical standards. Accordingly, future rate hikes required to tame inflation are much higher for western countries compared to India.

With inflation in India expected to come down below 6% post March 2023 and concerns on growth starting to surface, RBI may very well stop if it can. But it will be tough to do that.

Pausing rate hike will put further pressure on INR which RBI has been defending to keep under 80. RBI foreign exchange reserve is already down from USD 630 bn to USD 550 bn since Russia invaded Ukraine. With CAD expected to reach 3.5% of GDP this year, it will continue to put pressure on INR.

With major global economies staring at recession, INR depreciation is unlikely to help Indian exports much. On the other hand, allowing INR to depreciate will mean importing oil price linked inflation. So the aim of depending INR is not misplaced. However, costs of that will become higher going forward. Large FX reserves provides utmost important for country’s financial stability and RBI will have some redline number for that.

Answer may be in balancing all the parts -
• Allow INR gradually depreciate to 82-83 and preserve Fx reserve from too much erosion;
• Less aggressive rate hike of 0.35% in the upcoming policy keeping room for further increases of 0.50-0.75% over next 3-6 months.

02/09/2022

India’s inclusion in JP Morgan Bond Index

Renewed talk of inclusion of Indian Government Bonds in JP Morgan Bond Index has taken GoI 10Y Bond to pre RBI policy levels of 7.20% from post policy rate of 7.35%. This drop is even more remarkable when seen in the context of rise in global yields post Chair Powell’s speech – US 10Y rate has gone up by 0.25% to 3.25%.

Inclusion of Indian Bonds in JP Morgan and other global bond indices is matter of ‘when’ rather than ‘if’. After all it is difficult to ignore large, growing, stable emerging economy with domestic bond market of USD 1 trillion. This also means that there is no need for India to be desperate and allow concessions to foreign investors.

There are two outstanding demands from JP Morgan and other indices providers. One, no capital gain tax and settlement on Euroclear, a settlement agency widely used by global investors. Allowing latter also makes taxation by Indian very difficult.

It is absolutely logical that India has rejected preferential tax regime to foreign investors compared to domestic investors. There is no reason why Indian institutions and Indian tax payers helping build the nation should get worse treatment than foreign investors who are looking for returns (nothing wrong in that) and may just fly away when you need them most (when country’s macro are bad).

Settlement on Indian platform is equally important not only for control on taxation perspective but also from broader aim to develop bond market in India. We should not let this opportunity go waste. Trading on Indian platform will significantly increase secondary market liquidity in Indian debt market. Hopefully we will see liquid CDS market in Indian Government bonds followed by corporate bonds. Trading within India can bring many benefits which may not be even conceivable at the moment.

It is also important that India makes it easier for overseas investors to come and trade in India. Simpler process, or even automatic approvals for investors governed by respectable foreign regulators, should be looked at. Ease of investing will attract more capital and help lowering cost of borrowing for the government and eventually corporates as well as individuals.

It will be milestone for overseas investors as well as India to get included in global bond indices. But India should get that on her own terms.

01/09/2022

New bull run or crash ahead???

Equity markets recouped losses caused by hawkish comments made by Federal Reserve Chair Jerome Powell and other central bankers, reiterating their commitment to bring down inflation and indicating that interest rates may remain higher for longer period.

Market however is split over future course. One camp predicting sharp fall because of higher rates, lower earnings, recessions, etc etc. Another camp is banking against Fed raising rates too high lest it may break economy and hence back to lower rates and higher liquidity.

It is difficult to predict which scenario will come true but we will surely see a lot of volatility before things are clear. Market will see wild swings with each data points on inflation, unemployment, GDP, geo-political events to name a few.

I do not want to be in any one camp on where we are headed but risks rewards do not favour equity in my view. I would remain underweight equity in this situation and wait for clarity to emerge rather than go full on equity and pile up risks in my investment portfolio. Sometimes, it is better to keep your options open!!!

31/08/2022

10/08/2022

India Fixed Income investment becomes attractive


India 10Y Govt Bond yield moved up by 0.20% from pre-policy and currently trading at 7.30-7.35% range. Debt market expects few more hike this year with expected terminal Repo rate closer to 6% against 6.25-6.50% expected earlier when 10Y had touched 7.60%.

Inflation in India seems to have peaked with RBI maintaining its earlier forecast of 6.70% for FY23 and more importantly forecasting 5% for Q1FY24. RBI is also quite positive on growth front and kept its earlier projection of 7.2% for FY23 despite slowdown in global GDP and added fairly robust forecast of 6.7% for Q1FY24.

Considering inflation and growth dynamics in India, pause after possible 0.50% additional hikes seems very reasonable expectation. But joker in the pack would remain actions of Fed. Unlike India, US inflation remains substantially higher than target rate and with strong employment data, Fed may take rates higher than current market expectations. RBI in turn may be constrained in taking rates higher than required for domestic growth.

Looking at overall risk return dynamics of debt and equity, fixed income in India offers very attractive investment opportunities. With NIFTY trading at 5x earning yield, 10Y G-sec at 7.35% is indeed very good. After all, 7-8% return with low volatility is not bad at all and it should certainly find place in one’s portfolio to reduce portfolio volatility.

Some more uptick on the long term rates is quite possible, so it would be sensible to spread out investments over next 3 months.

21/07/2022

End of bear market or just another bear market rally?

After falling to 15200 last month, NIFTY has recovered sharply to 16550, rise of 9% from the low. So, natural question comes to mind whether worst is over?

With recession in US is becoming more likely, market is expecting lesser rate hikes by Fed eventually followed by rate cuts. Additionally, corporate earnings have remained strong. Backed by these factors, US indices have risen 7-9% from June lows. Indian equity also followed this rise.

But is worst over?
• Market is factoring mild recession (key reason for optimism) in US as unemployment rate is still at historical lows, personal & corporate balance sheets are strong and corporate earnings have been healthy.

• However, consumer confidence (As per University of Michigan survey) is at historical lows, expected inflation 1y forwards remains high and housing industry is now showing early signs of weakness.
• As unemployment is low, the risk of sharp recession remains low but there is risk of stagflation with low growth and high inflation. Situation in Europe is worse with ECB much behind the curve in raising interest rates.

• Risk associated with Quantitative Tapering will continue to remain in foreseeable future.

• China growth has slowed down considerably with most banks forecasting GDP growth of around 3.5% in 2022. Construction sector which has large share in GDP is in problem with developers under stress, homebuyers refusing to pay and now even suppliers refusing to pay banks.

• Indian export will slow down because of low global growth while import will continue to be high because of high oil prices leading to larger CAD.

• Q1FY23 earnings of Indian companies is expected to be strong on YoY basis because Covid Delta wave in Q1FY22. However, margins have already taken hit and earnings growth may slow down from next quarter onward with favourable base effect gone. RBI has projected GDP growth of 4.1% & 4.0% in Q3 & Q4 respectively. With global GDP slowing down, FY24 growth may be considerably lower than expect growth of 7.2% in FY23.

With all these factors and still unresolved Ukraine-Russia conflict, current rise in equity might be yet another bear market rally. As seen in the chart, bear market rallies are very sharp compared to falls. But, worst may not be over yet and we may have to wait few more months before are out of woods!!!

07/07/2022

Can Oil price really be capped?

Oil & gas has become key drivers of markets globally. It’s predictions are in the wildest range possible, USD 65/barrel (Citibank) to USD 380/barrel (JP Morgan).
However, more interesting news for me is that US, allies agreed to consider options to cap Russian oil at $40-$60 a barrel to cut war financing. https://economictimes.indiatimes.com/news/international/business/us-allies-discuss-capping-russian-oil-at-40-60-a-barrel-to-cut-war-financing/articleshow/92708310.cms

In my first Economics subject, 25 yrs back, I learned that equilibrium price is price at which demand from willing buyers and supply from willing sellers matches. During last few decades, most buyers & sellers were ‘willing’ to trade and so price was determined by demand and supply.

We are now in a world where some willing buyers (EU & US) have become unwilling buyers for trade with Russia. With decades of underinvestment in oil & gas production in these countries, there is limited ability to boost supply. No luck with OPEC too. So, we have strong demand backed by large Covid handouts by these countries, but lower supply and so higher prices.

The fresh plan is explore options to cap prices by banning insurance and transportation services needed to ship Russian crude and petroleum products unless the oil is purchased below an agreed price. I fail to understand why Russia will be willing to sell at this price if it can get much more and specially coming it from the West !!!

As a best case scenario, willing buyers (China, India, etc) will be able to manage shipping and insurance so still able to buy from Russia. This will still increase the landed price but let us assume by relatively smaller margin.

The worst case is of course, if the willing seller (Russia) turns into an unwilling seller. What happens then? More countries chasing rest of the willing buyers and driving up the prices to crazy levels and that would be anybody’s guess. More hardship on poor countries leading to bankruptcies, internal problems like Sri Lanka & Pakistan?

Russia has already cut gas supply by 60% to Germany, 50% to Italy and varying degrees to other EU countries. With EU’s stated plan of reducing imports from Russia by 2/3 by end of this year, isn’t it strategically better for Russia to stop entire supply to EU from its side? Winter is coming and it is the worst time to EU if this happens. Nothing to lose and good propaganda fodder for Russia. We will know if this nightmarish scenario becomes reality on July 21, scheduled date of reopening post routine maintenance starting July 11.

In the end, I just hope West does not put any more restrictions on Russia for energy export and drive Russia to take supply out of the market. Clearly sanctions have impacted the World much more than Russia itself. World is paying much higher price and there might be tipping point where common citizens even in US & EU may not support Ukraine in its war with Russia if pain is unbearable. And while Putin may not be worried about election, governments of the other countries still need to fight elections.

Allies have been exploring several ways to limit Russias oil revenues while minimizing the impact on their own economies in discussions that began in the run-up to the Group of Seven summit.