Remain constructive on India’s growth numbers; see need to monitor US 10-year bond rate: Morgan Stanley

Closer to home, Ahya says that recovery in Asia is driven by exports and capex. However, consumption continues to remain below pre-COVID levels.

“You have seen a very different recovery in Asia, it has been driven by exports and pickup in capex. So both exports and capex are way above pre-COVID path. But the consumption line item is still running below pre-COVID path,” Ahya said.

On the global front, with inflation in the US coming in at a 40-year high, and Federal Reserve indicating its plans to hike interest rates soon as well as shrinking its balance sheet, the world is in a quandary on growth. Ahya believes what is important in this context is to monitor what’s happening to the 10-year bond rate. Ahya explained that as the US Fed shrinks its balance sheet, real interest rates will rise. He mentioned that real interest rates could rise by 35-40 basis points (bps) by the year-end.

He said, "We think that the most important metric that you should look at from its impact on India and the rest of Asia is what is happening to the market-based 10-year real interest rates."

“The Fed is going to shrink its balance sheet and it is also going to lift policy rates. But we are expecting by end of 2022, you will probably see another 35-40 basis points rise in real interest rates and that should be manageable. So the pace at which US real rates rise, the magnitude by which the US real interest rates rise matter and those this time seem to be manageable for Asian markets,” he added.

However, Ahya is worried about potential volatility resulting from the US Fed’s move.

He said, “If you look at the 2017-18 experience, the Fed can if it guides well into the markets it can manage this in a way that it does not cause big tightening of financial conditions. But definitely the risks have increased. Because the balance sheet tightening is an important indicator that our strategists are also looking at. So we are concerned about potential volatility. But as I said, from a macroeconomic impact perspective, you would want to watch what the real rates are doing.”

Additionally, he expects inflation in the US to touch 2.7 percent by the end of FY22. He also added that US GDP has already reached pre-COVID levels.

“US GDP has already reached pre-COVID path, you know where inflation is, and it is quite far from Fed's goal. So from a tightening perspective, you can see that the economic conditions are such that any tightening at this stage initially should not be seen to be something that is restrictive. So we are far away from that point where the Fed will get restrictive,” he explained.

“If you think from real interest rates perspective, the Fed is expecting its core PCE inflation metric to reach 2.7 percent by the end of 2022,” he said.