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February 2013

The year has begun on a positive note. Equity markets maintained the upward momentum on the back of global cues, hopes of further reforms and beginning of monetary easing cycle in India. The market has been hovering close to a 24-month high for almost a month. India continued to outperform most of the other emerging markets.

News flow from developed economies was largely supportive for equities. Monthly indicators in key economies showed an improvement in growth outlook with no concerns on inflation yet. The risk of any near term reversal in easy monetary policy appears insignificant given the sustained aggression of central bankers from US, EU and now Japan.

Policy announcements remained supportive for Indian equities. The key initiatives like partial de-control in diesel price, hike in railway passenger fare, deferment of revised GAAR, and hike in import duty on Gold, clearly strengthened the communiqué on policy direction and force. Understanding the criticality of the Foreign Investors to the fiscal and monetary arithmetic, the finance minister conducted effective roadshows that were reassuring as regards the intent and execution roadmap in specific issues such as – fiscal consolidation, stable tax regime and a supportive policy environment for revival in growth.

Monthly data on growth and Inflation remained mixed. IIP for November came in at -0.1%, lower than anticipated mainly on the back of base effect, decline in sales post the festive season and contraction in capital goods (-7.7%). WPI inflation remained unchanged at 7.2%, while CPI headed higher at 10.6% vs 9.9% last month due to higher food prices. The core CPI number stood unchanged at 8.1%.

The government has accelerated its disinvestments process to achieve the budget targets. The amendments in the spectrum auctions to include existing players have also brightened the prospects of better revenues from this segment. The clarity on GAAR, modification of constraints for FII investments in debt funds and the policy overdrive drove in further investment flows through the month. These flows caused INR to appreciate by 3.2% in January.

The global rotation out of bonds in Equities and continued attractiveness of Indian markets led to FIIs pouring a record $ 4 billion in January. Domestic mutual funds on the other hand were net sellers with outflows of USD 875 million. The domestic redemptions seem to be peaking out and remain critical for further market direction.

We are in the initial leg of an interesting quarterly results season where the expectations are lower, performances are mixed (with a positive bias on surprises) and the market responses are violently sharp and instantaneous. As things stand now, the consensus earnings estimates for the broad market stand increased by 0.9% for FY13E and FY 14E over the month. The street now estimates earnings growth of 10% and 16% for FY13E and FY14E respectively. The breadth of earnings revisions also turned positive. Meaningful upgrades were seen in the IT Services and Energy sectors. Market would soon start factoring earnings beyond FY14E as we come close to end FY13E.

Most of India’s performance in CY12 has come in when the world has been grappling with issues on financial existence. India story, in the medium term, rests on domestic consumption, export competitiveness, supply side investment opportunities and revival of policy pragmatism and governance. India offers an interesting combination of growth at relative value for a global investor. We expect India to be among top-tier beneficiaries of increased allocation of global flows though there would be some risk-on/off toggle through CY13.

The union budget would be a key event to watch out for. Given the sharp rally in global equity markets, there could be corrections impacting our markets as well, however, we expect the environment of positive reflexivity to continue.

We reiterate our belief in our core strategy of investing in quality (business, earnings, cash-flow and management). Further, in an environment where market stands balanced at valuations of ~14.5xFY14E, we remain alert to participate in every such prospect that provides either tactical/ structural opportunity for our investors.

The RBI monetary review in January 2013 was widely anticipated to initiate the process of monetary easing after the pause since April 2012. Softening in headline inflation, significant moderation in economic growth and recent policy initiatives from the government led RBI to cut policy rates and CRR by 25 bps each. The policy stance has recognized the downside risks to growth as inflationary pressures seem to have peaked for the time being. The progress on fiscal consolidation and further moderation in the Current Account Deficit are likely to influence the timing and quantum of additional easing. The CRR reduction would infuse primary liquidity to the extent of Rs180 billion and is intended to ensure that liquidity conditions going forward do not constrain credit flows. The government commitment on maintaining the revised Fiscal deficit target of 5.3% for FY13 has been acknowledged by the RBI, removing the likelihood of additional borrowings in the current fiscal year.

The widening gap between the deposit and credit growth rates can constrain the systemic liquidity going forward and would require additional liquidity enhancing measures. CRR cut would ease the near term liquidity pressure but we believe that it will have to be followed by Open market operations to bring liquidity deficit in line with RBI’s comfort zone.

During the current financial year starting April 2012, the RBI has purchased government securities worth about Rs 1.3 Trillion though OMO’s and secondary market purchases which has absorbed about 25% of the gross supply till date. Prospects of additional OMO operations on account of seasonal liquidity pressures in March, along with the government reiterating the commitment of maintaining the FY14 fiscal deficit target of 4.80% are likely to keep government bond yields supported in the near term with a range bound trading zone. The Union Budget to be presented to the parliament in the last week of February 2013 would set the direction for market movements in the near term.

Government bond yields softened over the last month on monetary easing prospects and lesser supply with the 10yr yields closing at 7.91%. AAA corporate spreads marginally widened over the month and ranged around 74 bps in the 10yr segment.

We expect another 25 bps rate cut in March followed by additional easing in the next quarter contingent on the fiscal consolidation and supply side initiatives. We retain our positive bias for the bond market from a medium term perspective. Given the expectations of further policy rate cut and likelihood of fiscal deficit for FY 2013-14 coming in at around 4.8%, we expect bond yields to ease further. We have been maintaining relatively high duration in our long term bond funds through exposure to government bonds.


Navneet Munot

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