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April 2014

The equity market continued to rally from the previous month with the benchmark Sensex closing near a new high (up 6% m-o-m). While the rally has been attributed to expectations of a decisive mandate for a reform friendly alliance coming to power, improvement in India’s macro conditions is also playing a role in higher allocations from global investors.

The global growth outlook has been constructive as most of the economic data came in line with market expectations. While Euro zone and Japan remain committed to their respective expansionary monetary policies, the markets have adjusted to a gentle tapering of quantitative easing from US Federal Reserve. The political events in Russia and the finance sector concerns in China would remain critical factors to watch in coming months.

The domestic economic indicators have provided some relief with better series from inflation (CPI at two year low) and current account deficit (CAD at 0.9% - lowest in 8 years). Food inflation was at a 10-month low. Most of the street has now accommodated for a much lower numbers on the CAD as against the start of the year. The Rupee continues to benefit from incremental improvement in external sector account, increased market confidence in the central bank, hopes for a stable, progressive government after elections and also strong FII flows. Rupee today stands privileged to be one of the best performing and least volatile currency within the emerging market basket over the last couple of months.

The general elections are announced and the anchor has shifted to economic agenda of the key political constituents. On a closer look, development remains the least common denominator in political advocacy. As we fast forward from last election to the current, India emerges at almost the same relative position among its emerging markets peers when it comes to economic performance, outlook, and relative valuations. These elections provide a discontinuous opportunity for India where the outcome can enable to wipe out its deficits on economic performance and governance in the period gone by.

FIIs continue their faith and belief in the India story and were net buyers to the extent of USD 3.3 billion through March, while domestic Institutions remained sellers to the tune of USD 523 milion. Domestic investors have been underweight in equities as an asset class and a positive outcome in elections could be the trigger for reversal of this trend.

As we complete a financial year and move to the next results season, the pivot has shifted to likelihood of recovery and effects of monsoon. The market expectations for FY14E and FY15E earnings growth now stands at 8.8% and 17.5% respectively. Over the last quarter, market has responded to the opportunity space in mid-caps vis-à-vis large caps. We reiterate our belief that mid and small cap space offers tremendous opportunity from a long term perspective.

The last five years have made Indian corporates realize the necessity to remain prudent in its resource utilization. The efforts made during the downturn to reconstruct their operative and balance sheet structure makes them competitive to benefit from a triple play opportunity of cyclical revival in domestic economy (with better overheads structure), extending domestic franchise, and exploring/ expanding export footprint (with the export competitiveness). We remain encoded to seize these prospects at every value opportunity that the market presents in near future.

RBI in its first monetary policy meeting for FY 2014-15 maintained the status quo on policy rates with the broad direction of policy setting influenced by the Dr Urjit Patel committee recommendations. RBI also announced additional measures to further refine the liquidity management operations and listed various 

developmental and regulatory policies as part of the Five-Pillar approach dealing with financial markets architecture.

The policy stance underscores the disinflation “glide path” of achieving 8% CPI inflation by Jan 15 and 6% by Jan 16. Based on the current evolution of CPI inflation trends, RBI does not anticipate further policy tightening in the near term. In line with the recent RBI stance of de-emphasizing guaranteed liquidity access at the overnight repo window, the access to overnight LAF has been reduced to 0.25% of NDTL, along with increase in term repo under 7 and 14 days to 0.75% of NDTL. RBI has also announced new restrictions for foreign Investors invested in Treasury Bills, with a scheduled shift of the T-bills limit to minimum one year and above dated government securities. RBI has also cautioned about the year-end “window dressing” by banks, which have resulted in liquidity tightness and also abnormal moves in various segments of the financial market. The RBI is expected to announce proposals to mitigate these practices.

The RBI guidance cautions about the need to see through any transient base – effect reductions in headline CPI inflation, while also being alert to the possibilities of any upside surprises. In this context, the best case scenario would be for the RBI to remain on pause mode for a period of time, at least for the coming quarter. A more directional stance on rates would be primarily dependent on the new government’s fiscal stance, with external sector developments also influencing the outlook on inflation. A more pro active liquidity management as seen in the last few months with term repo being the primary instrument would ensure that the overnight rates remain in line with the prevailing policy stance and also the short end of the curve remains well anchored in the absence of any additional liquidity premium.

A directional move in bond yields would be dependent on a more consistent and durable easing in CPI inflation and also the fiscal stance. The Union Budget to be presented post the new government would provide a better clarity regarding the prospects of fiscal deficit trends and the likely market borrowings for funding the same. In the interim the borrowing schedule would be as per the interim numbers. The resumption of government borrowings after a gap of about 2 months would present its own challenges in terms of smooth market absorption as the RBI seems highly unlikely to do large scale OMOs with term repo’s being the preferred route for liquidity infusion in the short term. At the same time, the necessary reserve money injection in line with the broad credit-deposit trends may largely be provided through accretion to the Net Foreign Exchange assets of the RBI.

We have been maintaining a cautious view in view of the policy stance that is predominantly focused on anchoring consumer inflation and inflationary expectations and the near-term challenges on the absorption of the government borrowing. The front end of the corporate curve looks relatively attractive in the current situation on a risk – reward framework, with liquidity situation expected to be broadly better in the first half of this quarter. We would continue to watch the events on the domestic political and global fronts which can have any bearing on the interest rates.


Navneet Munot

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