The month gone by – A snapshot

Global markets rallied in May given the ceasefire in West Asia. Investors reacted positively to pickup in ship cargo traffic from the Persian Gulf, while continuing to show confidence in artificial intelligence-driven growth. Nevertheless, significant geopolitical uncertainty continues to weigh on sentiment and has contributed to bouts of volatility across asset classes.

Elevated energy, transportation and logistics costs have revived inflationary pressures across major economies. Some developed market policymakers have cautioned that continuation of inflationary pressures may necessitate raising of interest rates. Emerging market central banks, such as those in Indonesia and Philippines, have raised policy rates in recent months.

The MSCI World Index rose by 4% last month, while MSCI Emerging Market Index rallied by 10%. Crude oil prices declined by 19% in May amidst tentative progress towards de-escalation in West Asia. Energy prices however remain significantly above the pre-conflict levels. Rupee continued to face depreciation pressure on account of elevated trade deficits and continuing outflows from the equity markets.

Economy: Strong economic momentum faces near term headwinds

Indian economy continues to exhibit resilience supported by steady domestic demand. High-frequency indicators remain encouraging, with industrial production growth for April increasing to 4.9%, while strong domestic demand helped revive manufacturing PMI for May to a three-month high. GST collections continued to show steady economic momentum.

However, disruption in supply chains from West Asia, and consequent increase in energy costs, is a significant headwind, particularly for the industrial sector. The India Meteorological Department (IMD) projection of deficit in this year’s monsoon rainfall has emerged as a key risk for the rural economy. Both these factors are key monitorables for policymakers as well as financial markets.

Equity market: Consolidation continues

Indian equity markets continue to consolidate amidst macro-economic uncertainty induced by the West Asia conflict. In May, the Nifty index was up by 1% while Mid and Small cap indices rose by 4% each. Healthcare & Metals sectors outperformed while Fast Moving Consumer Goods (FMCG) & Banking sectors underperformed. Foreign Institutional Investors (FIIs) sold equities worth US$ 2.6bn, while Domestic Institutional Investors bought equities worth US$ 8.7bn.

The global economic situation remains fragile underpinned by the West Asia conflict. Rising energy prices are expected to induce inflationary pressures. This coupled with weakening demand indicators in select major economies is likely to have an adverse impact on global growth prospect. The recently concluded FY26 corporate result season witnessed improving trends across most sectors. The outlook for the FY27 is sanguine driven by improvement in nominal GDP growth and higher export-linked earnings. Valuations continue to remain attractive. However, a quick resolution of the conflict is key to faster stability of global and local macro-economic situation, consumer sentiments, and demand environment. We maintain our positive stance on equities from a medium to long term perspective.

Fixed Income market: RBI likely to be patient amidst increasing uncertainty

The retail inflation for April at 3.5%, remained below RBI’s midpoint target of 4%. Given benign inflation readings, RBI’s monetary policy committee is likely to adopt a ‘wait and watch’ approach and keep policy rates on hold in this week’s meeting. Policymakers are however expected to acknowledge the buildup of inflationary pressures on account of increase in energy prices and risk of higher food prices due to possibility of poor monsoon rainfall, and revise their inflation forecasts upwards.

Given deterioration in inflation outlook, many analysts have started to project the possibility of RBI raising policy rates later this year. Fiscal concerns have also risen on account of higher expenditure on food and fertilizer subsidy, and lower excise duty collections. However, these concerns have been partially mitigated by RBI’s record high dividend payment to the government last month.

After two months of outflows, FPI inflows into debt markets resumed last month with purchases of US$ 0.3bn. Bond yields continued to exhibit volatility on account of significant geopolitical uncertainties. The developments in West Asia combined with the progress of monsoon rainfall are key determinants of the yield trajectory, going forward.