Unmesh Kulkarni, Managing Director-Senior Advisor, Julius Baer India.
The RBI will have to weigh the risk of further inflationary upside, fuelled by the Ukraine crisis, against domestic growth from sanctions or potential slackening of demand, according to Unmesh Kulkarni, Managing Director and Senior Advisor at Julius Baer India.
He feels the Monetary Policy Committee (MPC) is likely to initially raise the reverse repo rate and bring the policy stance to neutral from accommodative, before starting to hike the repo rate. “We expect the RBI to raise the repo rate by 50 bps sometime in the second half of the year,” Kulkarni shares in an interview with Moneycontrol.
On the equity markets, he says that Julius would prefer to adopt a cautious stance for the near term and wait out for entry opportunities to materialise. Excerpts from the interview:
Do you think the oil prices will remain rangebound at $ 100 a barrel? In such a scenario, do you see a big risk for oil importers like India?
The Ukraine war and the accompanying sanctions have weighed heavily on the energy markets, and oil prices have, therefore, been at the centre of the storm. The oil market was already in a cyclically tight phase due to production cuts by some major oil production nations, and the supplies not matching the fast-recovering demand; the war-led supply shocks have further added fuel to the fire.
The United States is doing the heavy lifting of plugging the supply gap by releasing substantial quantities of oil from its strategic reserves and accelerating the shale oil drilling activity.
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Nevertheless, in the near-term, there is uncertainty regarding the duration of the war, and oil prices may continue to stay elevated for some more time. However, we find the current situation to be a price crisis and not a supply crisis. Our Global Research has a Neutral view on oil, and beyond the near-term supply shocks, they see the supply constraints as cyclical and not structural.
India’s heavy dependence on imports for fulfilling its oil demand certainly puts the economy at some stress in the prevailing $ 100+ situation. In the near-term, the country’s healthy forex reserves, high consumer savings, healthy systemic liquidity, strong balance sheets of banks and corporates, and an economy in an overall recovery trajectory should help absorb the pain arising from high oil and commodity prices.
However, a prolonged period of high oil prices would have its effects on consumption, as it would add to the already-existing inflationary pressures (WPI as well as CPI). Besides, the Current Account Deficit will also likely take a knock with sustained high oil prices.
What are your thoughts on the US bond markets? The 5-year and 30-year US bond yields inverted for the first time since 2006?
The withdrawal of the loose monetary policy and an increasingly hawkish Fed has sent the US bond yields soaring, with the 10-year benchmark yield rising from 1.3 percent-1.5 percent (in Q3 2021) to about 2.6 percent (at present).
After the inaugural 25-bps hike in March, the Fed indicated additional six rate hikes in 2022, taking the total hike to 175 bps. Inflation in the US remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures. While the bond markets in the US are already discounting a large part of the Fed hikes, we expect interest rates in the US to remain elevated for some time, with the possibility of heading even a bit higher from here.
The US Treasury yield curve inverted recently, with short-term yields rising above the long-term yields. In particular, bond markets tend to watch the 10Y–2Y treasury yield inversion, as history suggests a relationship between the inversion and the slowing of the US economy (towards recession). However, in most cases, the recessionary impact on the economy is not immediate, and takes around a year or two to play out.
As far as the US equity markets are concerned, they have corrected in the past, after inversion, but only after reasonable time, and after running up further from the month of inversion. Taking a cue from history, in the near-term, global equity markets could possibly take the inversion in stride and focus more on the strong fundamentals of the US economy, including healthy consumer demand, robust employment conditions and earnings.
In particular, US Financials, being value-investing, should do well in a higher-yield environment, while the IT sector in the US represents a structural growth opportunity and higher earnings.
Commodities are clearly at the centre of the shock unleashed by the war in Ukraine and the pursuant sanctions, as supply of energy, metals and agri-commodities were impacted. We believe that the war in Ukraine brings primarily a price crisis and not a supply crisis. Our Global team holds a neutral view on overall commodities and believes that while commodity/oil prices might see a further up move in case of further escalation in the geopolitical situation, they should see a down move within weeks or months.
With a bit of easing risk of Ukraine-Russia crisis, will the Federal Reserve turn more aggressive in rate hikes in the rest of 2022?
The Ukraine-Russia situation is still evolving, and it is a little early to say if the risk has eased. However, even when the markets were perceiving a slowdown in growth due to the Ukraine war and accompanying sanctions, the usual downward pressure on interest rates due to slowdown in growth has so far failed to materialise.
For global central banks, lowering interest rates to stimulate demand is currently not appropriate, as it would aggravate the supply problems. The high inflation rates provide an additional disincentive for cutting interest rates; we expect sizeable rate hikes by the US Fed in the next few FOMC meetings, with an imminent 50 bps hike in the May meeting.
Do you think the RBI would prefer to stay behind the curve or do you expect couple of rate hikes in FY23?
The Monetary Policy Committee (MPC) has stayed accommodative for a very long time, even though the worst of the pandemic is behind us. The MPC has been citing concerns of uneven growth, and wanting to see sustainable growth, before changing course. It seems to be content, for the time being, with allowing inflation to persist outside its comfort zone.
The RBI will have to weigh the risk of further inflationary upside (from Ukraine shocks) versus the impact on domestic growth due to sanctions/potential slackening of demand. Despite the war situation, the global central banks have taken a tough stand with respect to fighting inflation, while the RBI has stayed behind the curve.
However, the CPI has already been ruling higher than the RBI’s modest projections in the February policy (which should get revised upwards), and domestic fuel prices are back on the rise in an accelerated manner (after a longish pause), which will add further fuel to the fire.
With increasing global and domestic pressures, it is about time that the RBI moves a step forward, from liquidity normalisation to rate normalisation. The MPC is likely to initially raise the reverse repo rate and bring the policy stance to neutral (from accommodative), before starting to hike the repo rate. We expect the RBI to raise the repo rate by 50 bps sometime in the second half of the year.
Besides, the government borrowing plan announced for the first half of the new financial year is 20 percent higher than the corresponding period in the previous year, which is likely to keep the gilt markets under pressure, and the RBI will need to do timely interventions through open market operations (OMOs) to assuage the markets.
Do you think the current market recovery from recent lows (due to Ukraine war) will continue in coming weeks?
The markets have witnessed a smart recovery in the past few weeks, in line with the global markets, and have been surprisingly absorbing and adjusting to incremental news flow around the geopolitical crisis, inflationary pressures and tightening by the global central banks.
While it is extremely difficult to predict the market movements in the very short term, there are clearly some near-term challenges in the form of margin pressures and a weak demand environment, especially rural. A prolonged period of geopolitical situation and elevated commodity prices can also gradually start leading to demand destruction and weigh on economic growth.
Also, the impending mega IPO of LIC, which may be launched soon, considering the favourable market conditions, will lead to sizeable supply of paper and can weigh on the markets.
Hence, in the near term, we would prefer to adopt a cautious stance and wait out for entry opportunities to materialise.
If you have Rs 10 lakh and you want to split into asset classes, including equity, gold and fixed income. How do you go about it, as we just entered into FY23? Also, what is your allocation to large-cap, mid-cap and small-cap in the equity space?
In periods of global uncertainty and market swings arising from geopolitical tensions, and accompanied by high valuations, it is prudent to keep the portfolio well-diversified, across asset classes as well as product classes.
Despite the near-term headwinds and valuation concerns that could create short-term volatility, we think Indian equity markets will do well in the longer term, as there is a structural improvement in the earnings cycle. Also, equities have been the best asset class to beat inflation. For a moderate risk-profile investor, a 40-50 percent allocation to equities makes sense from a medium-to-long-term perspective, and investors could buy on dips or stagger their equity investments over a period of time.
Allocation to fixed income could be in the range of 35-40 percent, predominantly in shorter-maturity funds or debt instruments, in order to ride out the rising interest rate cycle.
Gold prices are very close to their all-time highs, and while gold does stand out in times of geopolitical tensions or high inflationary periods, keeping in mind the recent run-up in prices, investors can look at keeping about 10 percent allocation to gold, but buying into price dips.
Another asset class that investors could look at is real estate (in the form of Real Estate Funds and/or REITs), as we believe that this asset class is looking up after a long period of stagnation and should now do well with the overall capex cycle picking up in India over the next few years.
Within equities, the immediate preference, say 60 percent allocation, should be to large-caps, to ride out any near-term volatility, followed by mid-caps (25-30 percent) and small-caps (10-15 percent).
Investors may also want to do some partial hedging in their portfolios, by making some allocation to hybrid strategies such as balanced advantage funds, aggressive hybrid funds or dynamic asset allocation strategies.
Commodity prices are rising and inflation is a big headwind. What could be the impact on overall corporate earnings?
The persistent inflationary pressure definitely poses a risk to earnings estimates, especially if the prices were to remain elevated for a prolonged period. However, the impact is expected to be more pronounced on specific sectors/stocks such as consumption, auto and ement, while it may not lead to significant risk of earnings cut at the headline index earnings level. This is because the key sectors that are expected to drive earnings growth such as financials, IT, energy and commodities are far more immune to commodity price-led margin pressure.
While the companies more vulnerable to input cost pressures have been gradually taking price hikes, the entire pass-through may happen with a lag in the current weak demand environment. Hence, the margin pressure could possibly be visible for a couple of quarters.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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