Will the RBI's efforts to tame inflation, manage growth fail? UBS thinks so

UBS has downgraded India’s real gross domestic product (GDP) forecast for fiscal 2022-23 (FY23) to 7 per cent from the earlier forecast of 7.7 per cent. Beyond FY23, they expect the GDP growth to settle at a trend rate of 6 per cent and see inflation remaining above the Reserve Bank of India’s (RBI’s) comfort level for a few more quarters. 

High global commodity prices (largely energy) and slower global growth on Russia-Ukraine conflict and China's COVID-19 led slowdown in the June quarter; real income shock from energy price hikes, inflationary pressures and the labour market's incomplete recovery resulting in weakness in domestic demand; and the risk of reallocation of limited fiscal resources away from capex towards higher subsidies (food, fertiliser, etc.) to shield low-income households from the price shock are the three key reasons UBS has slashed India's FY23 real GDP projection.

“Going forward, we see risks of higher inflation than the MPC’s upper threshold of 6 per cent for at least three quarters (March, June and September 2022 quarters). In such a scenario, the statutory mandate of keeping inflation within the 2 – 6 per cent band in three consecutive quarters would be breached,” wrote Tanvee Gupta Jain, an economist with UBS in a co-authored note with Rohit Arora and Sunil Tirumalai.

While the RBI's monetary policy committee kept rates steady in its recent policy review in April, UBS expects the Indian central bank to hike rates starting June 2022 and sees the MPC cumulatively hiking repo (policy) rate by 100 basis points (bps) to 5 per cent by FY23-end.

Real GDP projection

India, it said, will be could be among the worst impacted in Asia in terms of widening trade deficit due to rising global commodity prices and sees India's current account deficit (CAD) to widen to 3 per cent of GDP in FY23 (assuming Brent averages $105 a barrel), up from 1.6 per cent of GDP in FY22 as per their estimates.

“This is well above the sustainable level of 1.7-2.0 per cent of GDP. Looking at India's oil price sensitivity, a $10 a barrel oil price rise widens India's CAD by $14 billion (0.45 per cent of GDP). The RBI has been resisting rupee movement, especially above 77 against US dollar. If the shock persists for longer, the RBI would have no choice but to let the rupee weaken past our base-case estimate of 78 for FY23-end. Our sensitivity analysis indicates a 5 per cent rupee depreciation would boost growth 15 bps and could increase inflation by 20 bps,” UBS said.

Slowing growth (global and domestic), rising rates at a time of elevated valuations, UBS said, is bad news for equities while maintaining year-end Nifty target at 16,000. 

"Rising rates, stretched valuations and higher inflation risks make us concerned about consumption sectors, while we like banks for their supportive valuations and positive sensitivity to rates cycle," the UBS note said.

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