From Chief Ratings Officer’s Desk

In line with expectations, the Monetary Policy Committee (MPC) paused once again in its second bi-monthly Monetary Policy meeting for FY2024. Moreover, it kept the policy stance (“to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth”) unchanged, with a 5:1 vote. This, in addition to the repeated emphasis on moderating inflation towards the 4.0% medium term target, clearly signals an extended pause with a decisive decline in inflation, necessary before the rate cut cycle commences.

The MPC cut its average CPI inflation forecast for FY2024 marginally to 5.1% from 5.2%, while reducing the Q1 FY2024 projections sharply to 4.6% from 5.1%, along expected lines. The Q2 FY2024 CPI inflation projection was also pared slightly to 5.2% from 5.4% earlier, while the Q3 and Q4 FY2024 projections were maintained at 5.4% and 5.2% respectively. Interestingly, the MPC has factored in a normal monsoon into its projections, while highlighting the need to monitor the spatial and temporal distribution closely.

The RBI Governor’s assessment of the current domestic economic scenario vis-à-vis the rest of the world was quite optimistic, highlighting the strengthening domestic macro fundamentals, amid resilient activity, moderating inflation, narrowing current account deficit and comfortable forex reserves.

Meanwhile, following India’s 2070 net zero target, over the next one-decade, domestic steelmakers have sharpened their focus on reducing their carbon footprint by as much as 25-30% through various technological interventions. The European Union (EU), the second largest steel-consuming block globally, recently signed the Carbon Border Adjustment Mechanism (CBAM), laying the framework for the imposition of taxes on embedded carbon imports from six sectors, which includes steel, aluminium, cement, hydrogen, electricity, and fertiliser. According to ICRA’s latest research note on the steel sector (Link), CBAM has been designed to bring in a level playing field for EU-based steel mills, as many struggled to adjust to the steadily rising carbon prices in Europe, which more than doubled since the start of CY2021. This resulted in elevated costs associated with the purchase of emission receipts at the EU Emission Trading System (EU-ETS) for exceeding the annual free emission allowances.

In CBAM’s ‘Transitional Phase’ between October 1, 2023 - December 31, 2025, the focus will be on the reporting of carbon, but without any financial adjustment for EU importers. However, from January 1, 2026, the EU importers will have to buy CBAM certificates, corresponding to the embedded emissions above the EU Emission Trading System (EU-ETS) benchmark levels. The price of these certificates will be linked to the weekly average carbon prices at the EU-ETS.

Consumer confidence, on the other hand, continues to recover from the historic low recorded in June 2020. As per RBI’s Consumer Confidence Survey of May 2023, household spending was buoyant over the last year on the back of higher essential and non-essential spending. This is expected to support retail sales for the tenants of mall operators. ICRA expects rental income for the retail mall operators to increase by 8-10% YoY in FY2024, supported by improvement in trading values due to healthy retail sales and contracted rental escalations. In FY2024, trading values are expected to improve by 4-5% with healthy sales across the product categories like jewellery, electronics, apparels and increase in spends toward food, beverages, and entertainment segments. Further, the rental rates are forecast to increase by 3-4% YoY in FY2024, driven by contracted escalations/lease renewals at higher rates due to healthy occupancy of retail malls. ICRA’s outlook on retail mall operators is Stable.

Inflationary pressures have been adversely impacting demand for fashion retail, particularly in the value-fashion segment. For the Indian retail industry, after reporting a stellar 51% YoY revenue growth in FY2023, revenue growth of fashion retailers is set to moderate in the current fiscal amid inflationary headwinds. According to our most recent industry analysis, revenue growth of 11 listed retail entities in its sample set will moderate to 10% in FY2024. Their operating profit margins (OPMs) are also expected to decline by 100 bps to around 5.7%, given the demand softening and continued high advertisement and promotion spending expected during the year. The rating agency currently has a Stable outlook on the retail sector.

Despite robust revenue growth in FY2023 (primarily led by network expansion), the OPMs trailed their pre-pandemic levels by 100 bps, given the demand slowdown and sharp increase in advertisement and promotion expenses undertaken by the retailers to make up for the lost sales of FY2021 and FY2022. Most large retailers also acquired/launched brands in newer categories, especially in the ethnic wear segment and have been undertaking substantial investments to ramp up these brands. Retailers as of now, have not indicated any reduction in ad-spends in the coming quarters as they are hopeful of demand recovery in H2 FY2024. ICRA also expects discounting levels to go up in H1 FY2024 as retailers look to shore up sales, which shall exert some pressure on the gross margins.

On a positive note, India Inc. has been witnessing a sequential expansion in margins in Q4 FY2023. ICRA’s analysis of the Q4 FY2023 performance of 579 listed companies (excluding financial sector entities) revealed expectedly positive revenue trends, with a YoY increase of 11.4%, while the sequential revenue growth was relatively moderate at 5.2%. On a YoY basis, almost all sectors reported revenue expansion in Q4 FY2023, with aviation, hotels, ports and gems & jewellery leading the trend. This was supported by the easing of commodity prices, which continued to positively impact consumer sentiments. In terms of sequential performance, sectors such as consumer durables, construction, port and gems & jewellery reported significant growth in revenues due to successive price hikes and strong demand witnessed in some sectors. On the other hand, few sectors like fertilisers and retail witnessed sequential decline in revenues during the quarter due to decline in realisations, following reduction in input costs.

ICRA believes that the sequential recovery in the overall performance of India Inc. is contingent upon how well the entities are able to cope with the headwinds going forward. General price increases undertaken by entities across sectors, coupled with stabilisation of input costs and easing of supply chain constraints such as semiconductor chip shortage, can pave the way for margin recovery in the coming quarters.

The issue concludes with regular features, monthly rating updates, upcoming ICRA events, and news features related to the company.

I hope you will find this newsletter useful and interesting.

Best Regards

K. Ravichandran
Chief Ratings Officer, ICRA Ltd.

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