RBI Rate Hike Considered Amid Geopolitical Uncertainty

RBI Policy Decision Reflects Market Expectations Amid Geopolitical Uncertainties

According to Rupesh Patel, the Senior Fund Manager - Equity Investments at Nippon India Mutual Fund, the recent RBI policy decision was in line with market expectations of no change in interest rates. However, the uncertainty surrounding the resolution of ongoing geopolitical tensions has led to downward revisions in growth projections and upward revisions in inflation expectations.

The RBI's decision to maintain the status quo on interest rates is a reflection of the current economic climate. Despite the downward revision in growth projections, the central bank has taken steps to encourage foreign capital inflows. The removal of withholding tax and capital gains for foreign investors investing in Government Securities is a significant move that is expected to attract stronger capital inflows into India.

This development is also likely to expedite India's inclusion in the Bloomberg Global Bond Index, resulting in sizable flows in the next few months post-inclusion. The amendment in the IT Act, removing withholding tax and capital gains for FPIs on Government Securities, is a positive step that should encourage foreign capital inflows.

Read also: RBI's Inflation-Focused Measures May Inject Up to $75 Billion into India, Improving Rupee Outlook

Table: Comparison of RBI's Growth and Inflation Forecasts

The RBI has revised its growth forecasts down and inflation forecasts higher, given the current uncertainties around the resolution of geopolitical tensions and risks of a weaker-than-normal monsoon on account of El Niño. If the current geopolitical uncertainties continue for longer, the risks to inflation, on account of the pass-through of higher global energy prices and the resultant second-order effects, significantly increase.

This, in turn, will increase the probability of a rate hike in the latter part of the year. However, the RBI's decision to maintain the status quo on interest rates suggests that the central bank is not yet convinced that a rate hike is necessary.

Read also: Eighth Pay Commission: Higher Fitment Factor May Increase Centre's NPS and UPS Burden

Outlook for Domestic Pharmaceutical Sector Remains Optimistic

Despite the current geopolitical uncertainties, Rupesh Patel remains optimistic about the outlook for the domestic pharmaceutical sector. The sector is expected to benefit from current trends around the outsourcing of research and drug manufacturing. Indian CDMO companies are expected to benefit from the current trends, while US generic companies, though struggling for growth, remain cash-generating and offer a favorable risk-reward from a valuation perspective.

Biofuels and Ethanol Sectors May Play a Marginal Role in Ensuring Energy Security

India's dependence on imports for a large part of its energy requirements makes it vulnerable to price and supply risks. Any form of alternate energy that can be sourced domestically will be positive at the margin. However, from a country perspective, the role of biofuels and ethanol sectors is likely to remain marginal.

Government and E&P Companies Taking Steps to Increase Domestic Oil and Gas Production

The government has recently taken steps to encourage investments in the E&P sector. The changes in government policy, including the reduction of royalty rates and simplification of wellhead prices, are expected to improve cash flows and profitability for E&P players. These amendments are also expected to remove regulatory bottlenecks and make the sector attractive for investors.

Removal of Interest Tax and Capital Gains Tax for Foreign Investors

The removal of withholding tax and capital gains for foreign investors investing in Government Securities is expected to attract stronger capital inflows into India. This development is also likely to expedite India's inclusion in the Bloomberg Global Bond Index, resulting in sizable flows in the next few months post-inclusion.

Expectations for Corporate Earnings in Q1FY27 and Q2FY27

Earnings for Q1, FY'27 are likely to be disappointing on account of inflation in input costs and challenges around logistics. Impact on Q2, FY'27 earnings will depend on how quickly current geopolitical tensions are resolved and supply chains are restored. If current geopolitical tensions continue for longer, risks related to deterioration in the macro environment, cost inflation, and logistics would assume significance, and we will have to consider the impact of these factors on earnings for the coming quarters as well.