Irrespective of what is being said of 2020, one thing is clear: it was far from being either dull or boring. Like Vladimir Lenin once said, “there are decades where nothing happens and there are weeks where decades happen.”
The year began on a sluggish note. Quarterly GDP for March 2020 came in at 3.1% and at 4.2% for full year FY 2020 as against 6.1% in FY 2019. Q1 (April – June 2020) GDP contracted by 23.9%, clearly the worst quarter in living memory. Q2 however rebounded to -7.5%, beating most estimates.
As we end the year, long end (10 year) yields are 50-60 bps lower than the start of the year, even as inflation is higher by 200 bps.
Outlook for 2021
Ironically, it appears that the economy needed a full-blown impact from a pandemic to shake it out of inactivity. After a difficult period since 2018, the economy is finally regaining a critically required momentum. As we stand ready to cross over into 2021, there certainly are a few silver linings.
Growth
Activity pre-COVID-19 was sluggish, financial conditions were tight, banking was besieged with asset quality issues and industry faced governance issues. Hence, even growth had thinned out to a trickle with Q4 – FY 2020 growing by a mere 3.1%.
The best offshoot of the pandemic has been in the form of ultra-loose monetary policy. Liquidity is surplus and perhaps already helping grease the demand cycle. High frequency indicators which were signaling a pick-up in August / September 2020, are faring well even post the festive season. Key data including, vehicle sales, power demand, railway freight, cement dispatches and GST collections are all showing strength. We expect FY 2022 GDP to inch up to low single digits (3 to 4%) before gradually returning to pre-COVID-19 levels (4-6%) by FY 2023.
Rates
On rates, we expect RBI to remain status quo for most part of 2021, prioritizing growth over inflation worries. Possibility of a rate hike remains low, despite rising prices, given that most of CPI surge is from the supply side or from food, both of which are outside RBI’s purview. As growth starts to pick up, capex would be needed, which will seek a lower cost of capital. Hence, higher rates now may not only puncture the incipient recovery but also discourage investments (supply side), with a potential to cause higher supply side inflation in the medium term.
Inflation
Inflation remains RBI’s Achilles’ heel for the moment. Even as growth remained weak through the summer months, inflation continued to rise from disrupted supply chains, sporadic lockdowns, import restrictions and a late monsoon surge in October.
While perishable inflation may soften starting January, the core presents a problem. Commodity prices have firmed up and remain strong maintaining an upward trend. Copper, aluminum, steel, all are at multi year highs as demand from China remains extremely strong. Oil is in the mid-40s and even the news of higher output by OPEC starting January has not led to a decline in prices.
Excise duties that were raised when crude fell steeply in March / April have not been reversed causing pump prices to touch record levels. All of this is likely to start causing some generalized pick up in costs / prices causing the core to stay over 5.5%. The MPC at its recent meeting has raised near term inflation forecasts by 100 bps as well. We expect headline inflation to remain in the band of 5.5% - 6.5% for most part of 2021.
Liquidity
Liquidity will remain a key monitorable in 2021. The current RBI dispensation recognizes liquidity as a potent tool to push through rate transmission and lower the cost of capital, even pre-COVID-19. It has hence stayed silent on liquidity while acknowledging inflation stickiness.
The current liquidity surplus has its source in RBI’s active secondary market purchases of government bonds. Current account surpluses and capital inflows have also added to forex flows. RBI has thus far chosen to mop up most of these inflows to prevent the rupee from appreciating, thus compounding the liquidity problem.
We expect RBI to resist the rupee appreciation in 2021 as well, preferring to build reserves to cushion any potential macro imbalance on the external front. Additionally, low rates help to discourage any unnatural currency inflows. In the process, RBI is likely to prefer using the reverse repo as the operating rate for as long as possible until it sights any macro imbalance on the local side such as aggressive risk taking by banks, improper risk pricing or any liquidity spill-overs / diversion into riskier assets including equity markets.
However, sticky inflation could play a party spoiler. RBI could respond at some stage by curbing some of the excess liquidity in 2021, either through liquidity suction or narrowing the corridor.
Debt products for 2021
Combination of a growth rebound, sticky inflation, high commodity prices and a resurgent stock markets call for a lesser broad-based stimulus and dim prospects of a rate cut. On the contrary, growth may have upside risks. Odds supporting an outperformance at the long end viz. 10 years and beyond is hence falling in our view.
In this backdrop, we prefer funds within a duration band of 2-5 years. Products such as the Corporate bond funds, Banking & PSU funds and Dynamic bond funds will remain core products for the year 2021.
(The writer is the CIO-Fixed Income, PGIM India Mutual Fund.)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
