CRISIL’s Financial Conditions Index (FCI) dropped below the ‘zero’ mark in March, indicating deterioration in domestic financial conditions.
The index provides a comprehensive monthly update on India’s financial conditions by combining 15 key parameters across equity, debt, money and forex markets, along with policy and lending conditions.
In March, the financial conditions were not only tighter than in the previous month but also relatively tight compared with average conditions in the past decade.
CRISIL’s FCI is responding to adverse impact from the external channel. Surging crude oil prices — a major influence on India’s macros — is weighing on investors. The US Fed hiked policy rates by 25 basis points (bps) in March and has indicated aggressive tightening this year. This has led to foreign portfolio capital outflows from India, a depreciating rupee, losses in equity markets, and rising yields on government securities (G-secs), all of which pushed domestic financial conditions into the ‘tighter zone’ in March.
So far, the RBI’s accommodative policy has been the major cushion for domestic financial conditions. However, rising inflation and external risks will make the central bank tighten its policy this fiscal.
We believe the RBI will hike repo rate by 50-75 bps over this fiscal, which will transmit to market rates and tighten financial conditions. Banks have already begun raising their MCLR rates post April monetary policy, indicating turn of the rate cycle.
The RBI has kept the repo rate unchanged since the onset of the pandemic. Given the trends in retail inflation, the implied real policy rate (i.e. the repo rate adjusting for inflation based on the consumer price index) has been negative since November 2019. The gap has widened in the last 6 months with rising inflation.
Bank lending rates as indicated by the 6-month MCLR (marginal cost of funds based lending rate), auto loan rate, and housing loan rate have been unchanged for the past 6 months, all lower than their respective pre-pandemic levels. Benign lending rates, along with improving economic prospects, is leading to a gradual revival in bank credit growth, which rose to 9.6% in March, the highest since December 2019.
The equity market was dragged down by negative global cues and large FPI outflows in March. The Sensex declined 2.2% on-month. The market also saw higher volatility, as indicated by Nifty India VIX rising to 25.1 in March from 22.1 in the previous month, and above the long-term average of about 20.
G-Sec yields hardened across the benchmark yield curve, driven by rising crude oil prices, beginning of US Fed rate hikes, increasing US Treasury yields, and large FPI outflows. Yield on the 10-year G-sec rose 7 bps on-month to average 6.83% in March, the highest level since June 2019. External factors are having a bigger impact on yields now that the RBI is unwinding its support to the bond market. The central bank has not been buying G-secs under its open market operations since November 2021. It has also been draining excess liquidity through variable rate reverse repo (VRRR) operations.