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April 2013

March was dominated by heightened fragility that emerged from the Cyprus issue which clouded the global investing environment. The market however remained range bound only to close 0.1% down m-o-m.

Economic indicators and news flow out of USA and Japan surprised positively and this combined with guidance of continued easy monetary policy helped outperformance in these markets. The crisis in Cyprus did reflect the underlying fragility of European monetary system, although a timely bailout did help investor sentiment.

Economic data on growth and Inflation remained mixed. Jan-IIP growth at 2.4% surprised positively (consensus~1.3%). While manufacturing and electricity numbers were in the green, mining at -2.9% reflected a slowdown due to environmental/forest clearance issues. The inflation data series displayed a rising trend for February with WPI printing at 6.8%. Core inflation eased to 3.8%. The RBI responded with a 25 bps repo rate cut in its policy.

The markets have weighed heavy with slower than expected growth, issues on instability of ruling coalition, declining growth in fixed investments and decelerating private consumption. It is ironical that at a time when the economic slowdown is becoming entrenched, India is witnessing classic signs of overheating like sticky inflation, high current account deficit, sharp decline in savings rate and rising property prices.

Continued interest in India on the back of policy commitment and the possible monetary action reflected in the FIIs flows. FIIs have been buyers for 10 consecutive months. In contrast, domestic institutions have been sellers now for nine months in a row.

We believe that macro has its own self-correcting mechanism where the constituents respond with necessary adequate sensibilities when a crisis strikes. One expects the slowdown to break the vicious cycle of adverse economics with corrective virtuous developments of fiscal prudence and judicious allocation of resources to augment the supply side (with necessary policy push to activities like oil exploration, power, roads and Railways (the big ones like DMFC and DMIC)) while addressing issues on deficits and inflation. Environment of softer commodity prices can provide a further tonic to any recovery. Every incremental effort to incentivize migration of savings from physical to financial assets (with PMLA applicable on buying of gold and real estate) should contribute to positivity.

The slowdown has overshadowed the emerging federal operative structure that states operate as dispersed centers committed to development and progressive heads of states have ensured that the collective economic growth stays above a 6% normal. Any possibility of a politically strong personality with dominant reformist image becoming a prime minister can provide further boost to positive reflexivity.

As we enter yet another earnings season, market is sitting tight on any direction. The results season would bring guidance and outlook of FY14E as an important undercurrent for the market. The concentration of financials and energy stocks coupled with an expected back-end recovery (and yes a softer interest rate cycle) are key assumptions in the current estimate of 14-15% earnings growth for FY14E. As we enter the season, the breadth of earnings revisions remains negative.

We continue to remain positive on the core India story of demographic dividend, knowledge economy, export competitiveness, supply side investment opportunities, and a proven long term DNA of economic development. The breadth of opportunities provided at near average valuations (at ~14xFY14E) makes it a fertile territory for investors.

We remain dedicated to invest in opportunities that the market offers in terms of business quality (business model, earnings, cash-flow and management), re-engineering (operations, resources, balance sheet) and valuations.

Indian entrepreneurs and investors are nervous due to what has happened in the last 5 years while ignoring the vast potential that lies ahead. The rearview mirror shows an ugly picture but markets are all about ‘change in perception’. Remember, cycles are getting shorter and a bull market may actually be underway while improvement “on the ground” and “in the numbers” may be round the corner. Global investors have been more optimistic on India, it is time, and domestic investors regain their faith.

In the mid quarter review of monetary policy in March, the RBI reduced the repo rate by 25 bps from 7.75% to 7.50% while keeping CRR and SLR unchanged. The guidance reiterated that in view of the elevated headline inflation and CAD risks, the headroom for additional easing is quite limited. Monetary easing in the current context is warranted given the sharp moderation in growth, easing core inflation and government efforts to address the fiscal situation. Elevated consumer price inflation driven largely by food products, high current account deficit and supply side bottlenecks have made the headroom for monetary policy support quite limited. Overall the policy guidance and outlook, stresses on the fact that growth revival would depend more on continuation of fiscal reforms, supply enhancing measures, improved governance on project implementation and efforts to revive.

Government bond yields moved up post the policy review on account of concerns regarding the RBI guidance on future rate actions. The 10yr benchmark yield moved up by around 5-6 bps over the month closing at 7.95%. AAA corporate spreads marginally widened over the month and ranged around 70 bps in the 10 year segment. Tight liquidity and issuance pressure resulted in bond spreads widening as anticipated.

We believe that soft global commodity prices, output gap, lag effect of tight monetary policy and fiscal correction will lead to softer inflation and lower current account deficit going forward. This would provide headroom for further monetary easing of at least 50 bps in policy rates with continuance of liquidity support in the form of Open market operations. The government borrowing calendar for 1HFY 14 was better than expected and with support in the form of OMOs, bond yields will continue to remain range-bound for the time being.

The rupee trajectory during the past year has remained volatile with concerns on CAD and flows shaping the near term direction. The Current Account Deficit for the Q3FY13 at 6.7% of GDP was on the higher end of market estimates. Recent pick up witnessed in trade numbers and higher invisibles are likely to lead to an improvement in CAD for the quarter ending March 13.

The seasonal improvement in demand- supply and incremental easing in liquidity are likely to lead to short to medium term AAA bond spreads tightening over the coming quarter. PSU AAA bonds provide higher accrual and also stand to benefit from easing liquidity and reduction of supply pressure post the fiscal closing. We had reduced duration by cutting Gsec exposure in our long term duration funds but would hasten to add that medium term outlook stays positive and would look to build Gsec exposure in the current quarter. We added short term corporate bonds and bank CDs as a tactical call that has paid off well. Our accrual products have also benefitted from the spike in short term rates in March.


Navneet Munot

(Mutual funds investments are subject to market risks, read all scheme related documents carefully.)