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August 2012

Amidst continued global uncertainties, India did outperform its peers in the month of July. The BSE Sensex closed 1.1% lower compared to previous month. News flow from developed economies was mixed. Economic data was largely disappointing. Policy environment in the European Union remains fluid. The ECB President’s assertion on protecting the Euro did boost investor sentiment towards the month end.In India, Union cabinet has been reshuffled with Mr. P Chidambaram taking over as Finance minister post the presidential election. Increasing voices of dissonance from key allies has led to moderation in the hopes of accelerated policy reforms.

Key monthly economic indicators of growth and inflation surprised positively, albeit the extent of surprise was limited. The recent spate of prior data revisions has caused market reaction to the data being somewhat tepid. In the monetary policy review meeting, the RBI left key rates unchanged and cut the SLR by 100 bps.

After witnessing a lot of volatility in June, the rupee traded in a far more stable band last month. The RBI also announced positive policy reversals. These changes along with a return in FII flows would have helped support the currency.

July witnessed official confirmation from the weather bureau that the monsoon is below normal this year. Recent studies do provide anecdotal evidence of better performance of the Agriculture sector in the last two drought years (2005 and 2009) on account of reasonable progress on sowing and better reservoir levels relative to 2009.

The month also witnessed highpoint of power crisis for two days and a landmark labor crisis in Maruti plant at Manesar. How India responds to these events in coming months would remain critical to the resurgence of Indian manufacturing on global canvass. The policy machinery has only taken marginal initiatives in terms of GAAR or Telecom Spectrum.

Equity markets moved in a narrow range as FII flows provided the support amidst the negative news flow. Foreign institutional investors (FIIs) were buyers of US$ 1.85 billion over the month. Year to date, FIIs have invested US$ 10.3 billion into Indian equities while domestic institutional investors have been net sellers.

The India story has its fascinating paradoxes. A weak policy making machine that is complemented by vibrant new emerging states. A fiscal deficit that is staring at an apparent crisis creating self-correcting currency that provides optimistic resurgence to Indian manufacturing competitiveness. A weak fiscal situation that can easily balance itself if the global slowdown corrects commodities/energy prices.

We have been through 2/3rd of the results season of 1QFY13. While the consumer and pharma results have been good, IT results have been mixed and overshadowed with murky outlook. Consensus earnings estimates for the broad market have been revised down marginally so far. The financials too have been

saddled with issues on asset quality. The street now estimates earnings growth of 13% and 14% for FY13(E) and FY14(E) respectively. Markets generally react to incremental changes on fundamentals, liquidity and sentiments. As things stand, India is witnessing a near-balance see-saw between its believers and naysayers. The sustained global flip flop on the Risk-On/ Risk-Off is helping the case neither. The period gone by has certainly prepared treadmill for trimming the growth expectations. Any external impulse (though negative in short term) on commodities does augur well for India. In the medium term, one can expect volatility as the only constant. The environment will reward investors who remain alert to the concept of value, and disciplined in their established rule-sets on what to do (and what not!).

We remain committed with our core belief strategy of investing in quality (business franchise, earnings, cashflow and management) while remaining alert to every opportunity that a volatile market provides on valuation. We also remain tactically agile to act on the trading opportunities that the markets would provide in these moments.

We continue to recommend that investors should use the downturn to increase allocation to equities as long term fundamentals remain intact. Valuations are reasonable and pricing in most of the risks on the horizon. Patient investors would be suitably rewarded for risks.

The recent policy stance of the RBI had highlighted the limitations of monetary policy in addressing the growth slowdown given the lack of adequate supply side and fiscal policy reforms. Market positioning since then had largely been factoring in some action from the Government on the administered fuel pricing and some of the long awaited policy reforms post the Presidential elections. Bond yields, traded lower in the first half of the month with the benchmark 10-year government security yields moving lower by around 12bps. Attractive yield spreads and improving systemic liquidity led to the 2-5 yr corporate bond yields moving lower by about 20bps and the corporate credit curve inversion getting corrected. The benchmark 10yr G-sec traded close to 8.05% in the first half, however, later it gave up the gains on account of lack of government initiatives on reforms/ fuel price adjustments, the near term inflationary pressure likely to arise from deficient monsoons and also the rebound in crude prices. The reduction in SLR in the policy review led to the benchmark 10yr yields to move up by around 10bps to close the month at 8.245%.

The RBI kept key policy rates on hold in the first quarter review of monetary policy for the year 2012-13 alongside a 1% reduction in the Statutory Liquidity Ratio (SLR) for banks. The persistence of inflation at higher levels in spite of growth slowdown, a lower output gap and the requirement of providing adequate liquidity have shaped the current policy stance. The reduction in SLR should be seen in the context of ongoing RBI efforts to ensure adequate liquidity for funding credit needs. The policy guidance, conditions further monetary easing on adequate steps by the government to address the supply side constraints. In this scenario, the RBI is likely to proactively respond to growth moderation. In the absence of adequate fiscal measures, the incremental RBI actions would be focused on ensuring adequate liquidity within the stated comfort zone and also to ensure that external shocks, if any, do not adversely impact domestic growth and financial stability.

The RBI commitment to pro actively address the liquidity constraints is likely to support bond yields, even as the fiscal side constrains aggressive monetary actions in the near term. Short term Income fund with its portfolio composition in short to medium term corporate bonds is well positioned to capture the opportunities likely to emerge given the anticipation of improved liquidity and likely steepening of the curve.

In the coming months, the net supply of government securities would be higher than the previous quarter which could result in near term pressure on long term yields, providing tactical opportunities to add duration. In view of the domestic growth moderation and the global trends in policy rates and market yields, there is scope for policy rates in India to move down further over the year. SBI Magnum Income fund has a core investment in medium term bonds with currently tactical duration positions in Gsec. This fund is suitable for investors having adequate risk appetite and horizon of over a year.

Navneet Munot
CIO – SBI Funds Management Private Limited

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