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December 2014

Equity markets continued to consolidate through November, with accelerated gains towards the end of the month on the back of benign outlook on crude prices. Year-to-date, India remains the second best performing market in its emerging market peer set.

Globally, growth indicators in key economies remained soft. Monetary easing in China and Japan along with signals from the European Central Bank (ECB) aided investor sentiment. Dollar remained strong reflecting relative strength in the US economy leading to expectations of a divergence in central bank policies. Chinese markets performed well in the previous month on the back of renewed interest of local investors. The recent OPEC meeting on 27th November suggests moderation in its traditional role of keeping supply and demand in check. The world capital markets are brewing from an interesting concoction of softer commodity prices, buoyant equities, and easy liquidity.

The new government completed its 6-months in office. The biggest achievement of the government is to reverse the cycle of negativity in the economy. It has prudently addressed most of the pain points when it comes to execution, speed of policymaking and commitment to reforms. The investment cycle has received an initial impulse with revival in some of the key projects in the roads sector earlier stuck in policy issues for fresh allocations/redressals. Orders for transmission expenditure and Dedicated Freight Corridor (DFC) have started. There is an increased focus on renewable energy. The recent ministerial expansions have further fortified the investment focus on key ministries such as Defense and Railways. States like Maharashtra and MP have already rolled the established template of Rajasthan for the labour reforms. Andhra Pradesh has rebooted on investment cycle. Government also responded to the situation on coal allocation with prudence backed by a spirit of fairness and transparency and a committed timeline. We believe the investment cycle is turning on the back of infrastructure spending while private capex will take some more time to kick off.

The winter session of parliament has begun on a positive note. The government is keen to get floor support to pass critical reform bills such as introduction of GST, changes in land and labour laws and 49% FDI in the Insurance sector. In the long term, government has also indicated its positive commitment to tax reforms both for domestic as well as international investors.

The government has also achieved revival of “brand India” in global political, business and investment map in a short period. While India was always “promising” to these communities, it stands repositioned as a “happening” destination. The rising growth differential that India offers has contributed further to this eco-political rerating. The figure of USD 40 billion strong foreign investment flow through CY14 is a signpost of the renewed international confidence in India. Next month’s visit of US President Obama for the Republic day parade is an indication of India’s pole position in all the strategy rooms in the world today.

Going forward, we expect the investor sentiments to remain positively influenced by internal factors like, falling inflation and interest rates, gradual recovery in economy on the back of rising consumer and business confidence, improved corporate earnings and persistence of reform initiatives such as faster project clearances and passing of important legislations. Sustained momentum of local investors would provide further liquidity to the markets.

The last six months have witnessed hyperactivity in the mid cap space. While valuations in this segment have crossed the large cap valuations, we expect this segment to provide opportunities of growth from winners in the new competitive environment. We have enhanced our investible universe to more opportunities in mid cap space and further increased our weight of cyclicals particularly in the industrials space.
A sharp fall in recent CPI readings below the RBI glidepath, weak credit and investment demand and also the correction in crude prices in the recent past had been expected to force the RBI to change the monetary policy stance in the December monetary policy review. However, the central bank has rightly stayed on course awaiting further data to validate the durability of disinflation impulses in the face of continued uncertainties especially related to agricultural production and also administered price corrections. Uncertainties surrounding the evolution of inflation post the reversal of base effects early next year and also the fiscal deficit targets have also supported a status quo at the current juncture. If the current disinflationary impulses sustain and fiscal developments remain encouraging, the RBI has held out the hope of a change in stance early next year, including outside the policy review cycle. Meanwhile, the Government is likely to formalize the new monetary policy framework in the coming months.

Overall the policy guidance can be read as being more balanced/dovish in relation to the September review as the Central Bank has held out the hope for a change in stance early next year subject to additional improvement in the key variables. A change in policy rate would be contingent on continued disinflation momentum leading to a more durable dip in CPI readings. The RBI over the last year has repeatedly emphasized the importance of stable lower CPI inflation as a perquisite for sustained growth. Policy rate actions and also policy tools have emphasized the same, with the RBI moving away from the multiple Indicators approach followed earlier. RBI is likely to get a better understanding of the CPI disinflation momentum adjusting for the base effects and also the fiscal deficit trends over the first quarter of CY15. Considering the overall improvement in Inflation trajectory and also weak investment demand, there is a high possibility of the RBI opting for a front loaded reduction in policy rates sometime in the first half of CY15.

Bond yields and swap levels have declined sharply over the month with expectations of the RBI stance undergoing a change. Foreign investors have invested a record $ 24 Billion in Indian bonds this year. With their limits for sovereign bonds getting exhausted, demand for corporate bonds has gone up resulting in credit spreads tightening substantially.

With a subdued credit off-take and improved liquidity, bank’s demand for government securities is likely to remain healthy in the near term. With the market incrementally looking at change in RBI stance, supported by weak commodity prices and softer CPI prints, the bond prices may remain well bid in the near term. At this point, we would expect that in spite of a challenging fiscal position, slippages are unlikely on account of subsidy savings, expenditure rationalization, large opening cash balances as well as likely big ticket disinvestment proceeds over the next few months. However, the progress on fiscal consolidation would continue to be a key variable affecting the RBI monetary policy stance.

We are maintaining higher duration through exposure to government bonds in our long term funds. We believe the G-Sec market offers better value relative to corporate bonds as credit spreads have tightened substantially.

Regards,
Navneet Munot

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

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