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July 2014

The  new  Government’s  initial  policy  signals  have  been  well  received  by  the  market.  India  remained  best performing emerging market for 1HCY14 with Sensex rising 4.94% during the month.  
The external backdrop too was mixed, with some signs of improvement in global growth outlook. Monetary policy remains extremely accommodative in most of the developed economies with European Central Bank announcing additional liquidity support to step up lending activities in the Euro zone. If the current trend of improvement  in  the  labour  market  and  consumer  price  inflation  continue  then  the  consensus  view  about
direction of US monetary policy may undergo a change. Markets have so far been complacent on that front as visible in valuation and implied volatility across asset classes.  The divergence between equity and other asset classes, particularly industrial commodities, is now at the edge of any further comfort.  
The  government  continued  on  its  agenda  of  creating  a  business  friendly  environment  and  focusing  on clearing the bottlenecks. It has gone ahead with the proposed fuel price hikes and has taken tough decisions like  increasing  railway  fares.  The  progress  of  Southwest  monsoon  has  been  worryingly  scant  so  far.  This
would  have  implications  on  food  inflation  and  rural  farm  incomes.  The  government  has  initiated  steps  in agri-distribution directed towards controlling the food inflation.  
The  market  has  crawled  over  the  wall  of  worries  and  is  now  taking  leaps  of  optimism.  Management interactions  are  filled  with  optimism,  and  markets  have  started  factoring  earnings  beyond  immediate visibility.  While  FIIs  continue  with  their  commitment  to  India  given  the  relative  attractiveness,  we  are witnessing a slow but steady improvement in interest from domestic investors.  
 thThe main event to watch out for is presentation of the  Union Budget scheduled on 10  July. This would be the first important economic policy document under the new regime. On the watch-list would be measures that  improve  revenues  (GST,  DTC),    subsidies  rationalization  (Food,  fuel,  fertilizer),  renewed  focus  on infrastructure,   particularly   on   encouraging   the   private   investments   and   the   funding,   direction   on disinvestments,   initiatives   to   capitalize   Public   Sector   Banks,   channelizing   the   domestic   savings   into productive  assets  etc.  India  has  to  find  novel  ways  of  funding  the  infrastructure  development  given  the limitations on the fiscal side as well as the banking sector. The uncertainty created by retrospective taxation measures  need  to  be  permanently  put  behind.  India  could  attract  significantly  higher  FDI  if  we  make  the environment more conducive with better clarity on policy matters, FDI limits and regulation. We expect the Budget to outline that roadmap with a promise of improvement in the “ease of doing business” in India. The
Finance minister needs to look at each expenditure item and shift the focus of budget from  mere “outlays” to a measurable “outcome” in line with the long term vision of the government. The fiscal maneuverability is extremely limited this year necessitating reliance on a large disinvestment program. We expect the Finance minister to outline  a credible path towards fiscal consolidation over the medium term. We  also have lot of
expectations from the railway budget as the sector has huge investment potential and is also very critical for the next leg of nation-building.   
The trend in earnings estimates reflects the view that growth recovery is likely to remain muted in the near term  but  should  strengthen  into  the  next  fiscal.  Corporate  earnings  remain  most  elastic  to  changes  in  real growth.  As  growth  starts  to  pick  up,  we  expect  the  market  to  be  driven  by  regular  earnings  upgrades  and
better  capital  efficiency  from  corporate  India.  The  changing  fabric  of  the  market  demands  adjustment  of investment  frameworks  that  participate  in  tomorrow’s  opportunities  today.  To  enable  the  same,  we  have enhanced our investment universe, with a sizeable infusion of cyclical component to our equity portfolios.

Macro  economic  data  points  released  over  the  last  month  showed  some  deterioration  in  inflation  prints even as growth data indicated signs of improvement.  The WPI data for May 14 registered a y-o-y growth of 6.01%  as  compared  to  expectations  of  5.34%  and  previous  month  growth  of  5.20%.  The  CPI  however
showed a decrease at 8.28% y-o-y for May 14 as against estimates of 8.40% and the previous month reading of  8.59%.  Growth  numbers  released  for  the  month  showed  sign  of  the  economy  picking  up  with  IIP  y-o-y growth  for  Apr-14  coming  in  at  3.4%  compared  to  the  0.5%  in  March.  The  HSBC  Composite  PMI  for  June
increased to 53.8 from 50.7 in the previous month. The trade deficit marginally deteriorated from USD 10.09 billion in April to USD 11.23 billion in May even as exports increased 12.4% on a y-o-y basis.  
Government  bond  yields  moved  up  by  about  7-10  bps  at  the  short  to  medium  segment  with  the  long  end correcting marginally  by  about  2-3  bps.  AAA  corporate  bond  spreads  however tightened  by around  10  bps due  to  lack  of  adequate  supply  as  issuers  grappled  with  several  provisions  in  the  New  Companies  Act. Improvement in risk appetite also contributed to the tightening in spreads. Near term concerns have arisen out of a spike in crude prices and a below normal monsoon. With the USD 20 Billion category of FII limits for gilt investments almost exhausted, incremental allocation in this space have to be made through the auction route,   thereby   limiting   additional   FII   purchases.   Renewed   confidence   in   the   monetary   and   fiscal management,  combined  with  higher  yield  spreads  could  continue  to  result  in  higher  FII  flows  in  the  debt space over time, even as the RBI adopts a cautious stance on incremental limits.
Overall the market may look to cues from the Union Budget announcement on 10  July for its medium term direction. We remain broadly positive on bonds over the medium term considering the government’s reform intentions  and  the  improved  monetary  policy  credibility,  while  remaining  cognizant  of  the  near  term  fiscal challenges.  Government  measures  to  address  the  challenges  arising  from  a  likely  deficient  monsoon  have been  more  prompt  and  also  further  supply  side  initiatives  may  be  rolled  out  in  the  agricultural  sector  to meet  the  structural  rigidities  leading  to  higher  primary  articles  inflation.  The  Union  Budget  would  provide better clarity regarding the prospects of medium term fiscal deficit trends and the likely market borrowings for  funding  the  same.  In  the  current  context,  with  the  government  looking  to  stimulate  investments,  we expect  a  re-  orientation of  government expenditure towards  more of  productive  Plan  Capital  Investments. With  prospects  of  additional  disinvestment  receipts,  any  expansion  of  the  fiscal  deficit could  be  funded without recourse to any large additional borrowings. We would look to signs of a more durable and credible fiscal  consolidation  in  the  Union  Budget  which  balances  the  need  for  expenditure  curtailment  with productive plan spending especially on the supply side even in case of an increased borrowing number.  
We  have  been  maintaining  a  higher  duration  considering  the  improved  medium  term  view.  The  concerns arising out of the likely deficient monsoon and the Iraq crisis with its impact on inflation can be mitigated by strong government measures  that seek to address the structural factors leading to inflation persistence. In view of the same and also considering the global yield levels, current absolute yield levels look attractive for
investments over a medium-term horizon

Navneet Munot

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