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February 2015

US President Obama’s visit to India on the republic day has opened a new chapter in bilateral relationships between two great democracies. The much awaited nuclear deal being signed, the two nations expect to expand their trade relations multifold over the next 5 years.

India is firmly back on the radar for the global community as witnessed in the World Economic Forum (WEF) at Davos. A large part of the world is staring at a growth cliff with central banks trying to fight hard through monetary easing. Commodity prices led by energy and metals continued their downward spiral. Growth scare, falling commodity prices and quantitative easing by European central bank led to further decline in bond yields. Short term bond yields in most of the developed world are in negative zone. Investors also need to pay attention to the geo-political risks given the recent terrorist attacks and political developments in Greece and other parts of the Europe. Amidst all this, India is not only benefitting from the fall in commodity prices but also staying as relatively attractive investment destination offering higher growth prospects. Foreign investors pumped in over $ 2 billion in equities last month. With a good part of these flows coming in from ETF investors, large cap indices outperformed mid and small caps.

Rupee appreciated by about 1.86% and remains one of the better performing currencies globally. Rupee may not remain immune to any sustained broad based dollar strengthening; however, the RBI appears to be vigilant towards any undue real appreciation of the currency driven by potentially volatile flows.

The formation of NITI (National Institute for Transforming India) as premier think tank replacing the erstwhile Planning commission symbolizes a major ideological shift in the economic policy and governance. Vice-chairman appointee Prof. Arvind Panagaria has been a strong votary of growth oriented policies and next generation reforms.

The government has acted smartly on fiscal side by opting for ad-hoc duties on fuels to capture the benefits of the falling crude price to create future reserves. The proposed disinvestments in cash rich PSUs and telecom spectrum auctions remain vital in the fiscal equation. While the government has refrained from any big bang announcements, there is a noticeable change on ground with its baby steps to instill confidence in the business environment. Over the last few months, it has slowly but steadily improved the investment template with focus on “ease of doing business’. The coal imbroglio stands addressed with a template of resource allocation that is fair and transparent. Most proposals stand cleared by the environment ministry while the behemoths of defense and railways are reviving their plans for modernization and localization. The government, with its decision of not contesting the Vodafone tax case has given the right signal to investment fraternity on the tax policy that rests on transparency, simplicity, stability and predictability.

The results season thus far has been dull with several companies reporting a weak quarter. There has been a wide miss to estimates and with revised estimates the market is now trading at a forward P/E of 16 times. While we maintain our positive outlook given the improving macro, softer interest rates, better business climate and near average valuations, we expect markets to consolidate their gains in the near term. A large part of the flows are likely to be absorbed by the supply of equity issuance - particularly for divestments and from the banks. Markets would be tracking the global developments apart from the management commentaries on earnings outlook with Union budget being the next big event to watch out for.

The RBI delivered a surprise Repo rate cut of 25 bps on 15th January. Sustained global disinflation momentum and weaker domestic demand seems to have prompted the rate cut with expected outcome in terms of signalling a change in monetary stance and possible reduction in bank lending rates from current levels. During the regular policy review on 3rd February, the RBI kept policy rates unchanged and reiterated that future course of policy rates would be dependent on high quality fiscal consolidation and continued disinflation momentum.

The macro data points released over the last month provided encouraging signals both on the inflation outlook and IIP growth. The CPI data for December-14 came in at 5.00% y-o-y as against 4.38% y-o-y the previous month. The change in base year and calculation methodology has led to a revised GDP growth rate from 4.7% to 6.90% for FY 2013-14 even as GDP at market prices has remained more or less constant. The CPI index also would undergo a base year revision with minor modification in sub-indices in line with the revised consumption survey data. The impact of these data revisions may be factored in the RBI assessment of expected growth and would be clear by the April Policy review.

The key theme for markets going forward would be the expected additional easing in policy rates which could largely be determined by the fiscal stance, given that CPI seems likely to settle below the RBI target of 6% by Jan-16. The RBI policy stance also seems to have been conditioned by the policies followed by global central banks and the resultant spillover effects. RBI measures pertaining to FIIs indicate preference for long term and more stable portfolio flows.

Supportive fiscal and other supply side measures are required to validate any sustained policy rate reduction. In this current context, policy rates could have more of a signaling influence. Considering the overall improvement in Inflation trajectory and also weak investment demand, there is a high possibility of the RBI opting for an additional rate cut in the current quarter on the expectation that the Union Budget presents a realistic and durable fiscal strategy. Incremental measures on the policy rate would be data dependent and also subject to the inflation targeting regime that is likely to be instituted over the coming months.

The RBI stance along with fiscal consolidation measures provides a sound footing to revive growth in a non-inflationary manner with macroeconomic stability. Globally bond yields are at record lows and might be close to testing the bottom, however, the overall deflationary momentum remains strong and present a favorable backdrop for interest rates in India. Overall, we would be inclined to maintain relatively higher duration given the positive view on interest rates.

Navneet Munot

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