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April 2012

March 2012 provided with it an unusual excitement of three key local events of politics, policy and budget. The market responded to the outcome negatively with a high volatility and the BSE Sensex closed down 2% month over month.

Recent news flows from the developed economies were mixed with data points from the US surprising positively but disappointing trend in Europe and China. European policymakers have so far been successful in avoiding a credit crunch, but economic indicators suggest a continued soft phase for growth. Policymakers managed a bailout for Greece but with strict austerity measures and lack of growth drivers, solvency issue will crop up again in sometime.

In India, the economic indicators showed a mixed picture:

  • Inflation accelerated marginally during the month (for February) to 6.95%, largely on account of increase in the prices of primary articles. 
  • IIP data (for January) positively surprised, rising 6.8% Y-o-Y. Output of eight core industries rose to 6.8% in February’12 from 0.5% in the previous month.
  • The rupee depreciated 3.6% and 3% against the USD and the Euro, respectively. Forex reserves are close to 17 month lows.
  • Balance of Payment (BoP) situation has raised its first flag with current account deficit rising to 4.3% of GDP for quarter ending December 2011. 
  • The bond yields continued their upward trajectories. Short term yields touched a 3½-year high. The yield curve remained inverted during the month.

The most awaited big events did provide a small twist in the India story, as:-

  • Ruling Coalition at the center performed poorly in assembly elections. The key state of Uttar Pradesh witnessed renaissance of the regional party, Samajwadi Party with absolute majority. The results have certainly ignited probabilities of new equations at the center with an outside chance of elections before schedule.
  • After the Rail Budget fiasco with an alliance partner, the Government presented a budget with a balanced picture when it comes to fiscal targets. The 2009-10 stimuli were partly withdrawn with incremental (wider and deeper) tax structures. The markets were disappointed due to lack of announcement of any reform initiative which could uplift the economic growth and investor sentiments. 
  • RBI cut the CRR by 75bps to 4.75% ahead of the monetary policy which was due on March 15th. This was higher than the market expectations of 50bps.
  • Most of the post-budget market diaries were full with discussion on GAAR - the Government has retrospectively clarified rules on income arising outside India on transfer of assets situated in India. This has created confusion on whether income of P-Notes holder coming via tax havens will be taxed.

The market liquidity remained good with FIIs being net buyers to the extent of USD 1.7 billion as compared to an inflow of USD 5bn in the previous month. Domestic mutual funds on the other hand were net sellers with outflows of USD 280mn vs. an outflow of USD 420mn in February 12. Also peculiar was a surge of supply in the market which has witnessed unprecedented appetite for quality liquid stocks.

The outlook on economy, earnings, policy and sentiments remained mixed. As things stand corporate India is at crossroads in terms of its future capital commitments. The Indian paradox on its policy ecosystem remains with persistent flare up on various scams. While resolute solutions to issues such as coal linkages, price deregulation and SEB restructure in power and the toll road awards have got initiated.

We enter the new earnings season with cautious optimism with increased possibilities of bottoming of the earnings downgrade cycle. For India, crude oil remains a critical lever to its overall equation, as the current systemic equilibrium assumes a scenario where crude and currency both hold on in a range for coming quarters.

The last financial year did provide us with some of the toughest challenges in equity markets where almost everything on economics, politics, and regulations have gone adverse. Most of our equity strategies across asset classes have managed to navigate this environment with success backed by our core beliefs on businesses that deliver cash flows, shareholder returns, and strong franchises. We expect to sustain the same, with tactical accommodation of cyclical and rate sensitive stocks at opportune times.

Liquidity deficit in the banking system remained substantially above the RBI’s stated comfort zone during the month of March. Seasonal cash deficit and the buildup of government balances towards the month end resulted in 3 month Bank CD’s trading close to 11.50% and 1 year CDs near 11%. The impact of the 75 Bps CRR reduction on short term rates was muted on account of heavy supply that coincided with tight liquidity. The benchmark 10-year Government bond yields moved up around 30bps after the RBI policy review and the Union Budget as the RBI gave no direction as to the policy action in the April review and the net borrowing number for FY13 at Rs 4.79 lakh crores came higher than most market estimates.

Liquidity situation is likely to improve substantially in the beginning of the new fiscal year primarily led by government spending and huge bond maturities. This should enable short term rates to moderate from the elevated levels which we have witnessed recently. A structural improvement in liquidity would be dependent on the credit – deposit growth numbers as well as the trends in the Forex market. Incidentally the RBI’s Forex intervention since Sep -2011 has drained about Rs 1 lakh crores in rupee liquidity which has offset the impact of CRR reductions and some of the OMO purchases. We expect the long bond yields to remain under pressure in the first quarter since the auction schedule is front loaded and the market absorption capacity may be tested in the absence of OMO’s by RBI. Over the course of the year, the RBI is expected to reduce policy rates in a sequenced manner which should support yields in spite of heavy supply. Trends in international crude prices and the absence of credible medium term fiscal consolidation measures could constrain the extent and pacing of rate reductions in this cycle. With near term growth prospects weakening and the budget estimates on expenditure growth being more realistic as compared to the previous fiscal year, a rate reduction in the April review could be a possibility at least from the signaling angle.

We have actively re-priced portfolios of the money market schemes considering the elevated yields and the maturity profile. On the duration side, our schemes have maintained a lower duration over the month. Going forward we would look to add duration opportunistically as the resumption of supply is likely to provide tactical opportunities. We would wait for further clarity on the rate cycle to add duration on a more sustained basis.

Regards,

Navneet

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