Market Round-Up 2022: Inflation, Ukraine, Interest Rates and More

The year 2022 has been a momentous year from many aspects. Of these, the Covid-19 pandemic phasing into an endemic, Russian invasion of Ukraine, global inflation prints at multi decade highs, persistent supply chain disruption are the ones that are likely to have far reaching impact. Despite these global headwinds, the Indian economy continued to grow albeit with its own problems of sharply depreciating Rupee and high inflation. As a result, after adjusting for inflation, returns for the year from both equity and debt were broadly in the negative zone.

Inflation is probably the single largest factor that impacts yields. RBI, like other global central banks, has been rapidly hiking rates and tightening liquidity in a bid to anchor inflation expectations. The broad consensus is that the peak of inflation is behind us however, it continues to remain a concern. The core inflation has been sticky at elevated levels and inflation has been pervasive i.e., more than half of the constituents of the inflation index is contributing to high inflation. It will thus take time for inflation to come down and stay within central bank's target band on a durable basis.

The fiscal deficit for the next financial year will be another key focus area specially as it would be in the run up to the general elections. A high fiscal deficit will mean increased market borrowings which could push yields upwards. Banks are already sitting on excess government bond holdings and with increasing credit demand, they may not be willing participants to the borrowing program. Further, with rates continuing to stay high in the USA, and no definite certainty on India's inclusion in global bond indices, flows from FPIs is also unlikely.

On the global front, the US Fed continues to raise rates and expects that it will have to maintain rates higher for longer to control inflation in the US economy. The FOMC projects to take the FED rate to 5.1% and to reach its desired target inflation rate of 2% only in 2025. The geopolitical tensions in Europe continue without an end in sight, and the new wave of Covid-19 indicates possibilities of more supply chain disruptions. These factors could arrest the slide in commodity prices that were easing on the back of global recession fears.

Investors have weathered significant volatility in 2022 and they should be ready for more in the coming year. The impact of steep rate hikes and lower liquidity though already visible, are going to be more pronounced in the coming year. RBI is likely near the peak of its rate hike cycle and may take a long pause to assess the complete impact of its actions. However, investors should not construe this as a shift to an easing stance. Given the prevailing uncertainties, both at domestic and international level, chances are that rates may remain elevated in India too for a long period. The current repo rate is at 6.25% and RBI has projected inflation to be at 5.20% for next financial year. For fixed income investors, this is good news, as real interest rates turn positive leading to healthy returns from debt assets.

(About the author: Anand Nevatia, the author of the article is Fund Manager, Trust Mutual Funds)