By Mahesh Patil

The global growth momentum continues to be moderate amid the most aggressive and synchronized global central bank tightening in the last 40 years, elevated uncertainties on geopolitics, and China’s ongoing zero-Covid policies. The global growth forecast for 2022 has been downgraded to 2.9 per cent, which was 4.4 per cent at the beginning of 2022, with current growth nowcast in the sub-2 per cent range. Importantly, the forecast for 2023 stands at 2.3 per cent, which makes it the third-lowest growth in the last two decades and the lowest growth outside of the global financial crisis and the peak pandemic shock. However, despite the faltering growth momentum, global CPIs, particularly in advanced economies, have remained at uncomfortably high levels while slowing, which has made choosing policies in the current business cycle more complicated.

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Jerome Powell, the chair of the Fed, recently shared the three indicators of monetary tightening — the pace of rate hikes, terminal rate, and duration of elevated rates. He said that while the pace of rate hikes may slow slightly, the terminal rate is likely to be higher than anticipated and likely to stay high for a longer period of time. Thus, the slowdown is the “base case” for the global economy now, and the debate has shifted to how “deeper and longer” such a slowdown will persist. After misjudging inflation as transient earlier, the Fed is likely to err on the side of hawkishness until there is clear evidence of inflation moderating. The markets are currently pricing a terminal rate of 5.1 per cent in 1H 23, which seems on the higher side to us. Thus, if the Fed delivers what markets are pricing, we expect the global growth slowdown to be longer.

The good news is that high-frequency indicators for India remain healthy: PMI readings are still strong, banking credit growth is the strongest in a decade, GST collections are robust, capacity utilization levels are inching upwards, supply chain pressures easing, and there are some early indications that CapEx is picking up. However, indicators like 2W and tractor sales remain subdued, reflecting an uneven recovery with lower-income groups still experiencing hardship. Despite the sound economic momentum, there are headwinds to growth due to the global slowdown as well as tighter monetary policies. Thus, we anticipate India’s growth will edge closer to 5 per cent.

The Indian economy is more of a source of worry due to macro-stability issues. Indian external account remains under pressure with a trade deficit led by oil remaining uncomfortably high in an environment of tightening global monetary policy. The Reserve Bank of India (RBI) forex reserves have fallen by US $86 bn in this fiscal and the forward book declining by a further US $60 bn. While revaluation contributes significantly to the decline in reserves, we need to note that such high trade deficit is unstainable, which is the primary source of pressure.

Besides the pressure in the external account, another macro-stability variable viz inflation remains a concern. Even at lower growth, Indian inflation has averaged 6.4 per cent for the past 12 months and 6.1 per cent since the beginning of the pandemic, both of which are higher than the RBI’s inflation target. While we are likely to see a decline in headline inflation in the forthcoming readings due to base effects, the inflation momentum remains elevated both in the core and food inflation segments. We expect food inflation momentum to remain elevated in the next few months due to the unseasonal and erratic rainfall in the monsoon season.

Down the road, we expect that the Government’s efforts — which it has done successfully in recent years — will be essential to bringing down food inflation. Our average inflation expectation for FY23 stands at 6.8 per cent, which is slightly higher than the RBI’s forecast of 6.7 per cent. Additionally, we must see Indian inflation in the context of a global surge in inflation, the rise in global commodity prices, and Covid-related shocks. In fact, one can argue that our inflation shock has been much less than what is visible in most major economies. However, what would bother RBI is that no matter what the source of inflation is, if it remains elevated for an extended length of time, then it begins to get entrenched, raising inflation expectations, and making future attempts to lower it more challenging and expensive.

Thus, the monetary policy action will be guided by the twin challenges of preserving both the internal (inflation) and external value (exchange rate) of currency. While slower growth won’t warrant an aggressive further rate hike, the aggressive rate hike cycle by global central bankers and the need to preserve financial stability are reasons why monetary tightening needs to continue. We, thus, expect further rate hikes by RBI and a terminal repo rate of 6.50 per cent, with crude prices to be the biggest headwind from a macro perspective. Liquidity has swung to a marginal deficit from a large surplus in the last six months and is to be carefully monitored as we enter into the busy credit season.

There continues to be an “unusually” large amount of uncertainty and volatility in play, and we continue to remain nimble in terms of our positioning. We think 10-year G-sec are likely to move closer to 7.75 per cent in the months leading up to March 2023. Short-term rates usually get impacted by likely policy actions in the near term, expected liquidity scenario, credit deposit demand conditions, and the impact on financial stability due to global factors. There is now more uncertainty than ever, which will likely put pressure on short-term rates in the future. In terms of fixed income, nominal rates have hardened by 275-300 bps in the last six months on the shorter end, and are now proving to be good investment prospects for fixed-income investors.

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As opposed to other fixed-income opportunities for short-term deployment in these uncertain times, we would advise investors to invest in ultra–short-term, money market, low duration, floater, and short-term funds, which continue to be the best risk-adjusted places for fixed-income investors. For long-term investors too, absolute levels are looking attractive near the three–four-year mark, especially for sovereign exposure. Investors can participate in this through any of the passive strategies in Debt Index funds.

In conclusion, for the first-time post-Covid, fixed income is emerging as a strong alternative to other asset classes on a risk-adjusted basis. Given this context, investors should reevaluate their total asset allocation and view fixed income as a positive bias now.

(By Mahesh Patil, Chief Investment Officer, Aditya Birla Sun Life AMC. The views expressed are the author’s own. The views expressed in the article are of the author and do not reflect the official position or policy of FinancialExpress.com. Please consult your financial advisor before investing.)