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January 2013

The equity market rose to a near 2-year high (Sensex was up 0.4% m-o-m) on the back of sustained global cues and hopes of further reforms. India was among one of the best performing market among its Emerging markets peers.

A near term solution has been found to avert the “fiscal cliff” in the US which has ignited a ‘risk-on’ trade. The new government in Japan has promised an aggressive fiscal and monetary accommodation which will also aid to global liquidity supporting asset prices.

At home, the winter session of Parliament was productive with successful political navigation by the ruling alliance to get approvals for FDI in Multi-brand retail, Banking Amendment Bill and Companies Bill. The rechristened NIB – Cabinet Committee on Investments (CCI) was instituted to fast-track infrastructure investments. Recent decision to move over to direct cash transfer for key government schemes and subsidies provide comfort on the medium term fiscal direction.

Monthly data on growth and Inflation surprised positively. IIP for October surged 8.2% y-o-y. The positive swing was on account of stronger-than-expected growth in Consumption – both Durables & Non-Durables. WPI inflation eased to7.2% y-o-y in November. The improvement in inflation was on account of low food inflation and lower core inflation. Core Inflation at 4.5% y-o-y was almost at its three-year lows.

The trend in trade deficit continues to be worrisome, however, as things stand investment flows have provided a good counterbalance. The INR depreciated 1.3% through the month. YTD, INR depreciated by 3.6%. We expect rupee to stabilize at current levels with scope for marginal appreciation in this year.

December witnessed offer-for-sale of equities by couple of companies which absorbed some of the high-tide liquidity. FIIs were buyers of US$ 4.6 billion over the month. Domestic Institutions sold equities worth US$ 1.6 billion in December. Over CY 2012, FIIs invested a substantial US$24.4 billion into Indian equities, while the Domestic Institutions sold US$10.8 billion.

As we complete the year – where the markets have substantially surprised on the upside, the onset of next results season would be among the key determinants of the market (along with fiscal clamor of what might be the last budget of the ruling coalition). As we move into the earnings season, the earnings revision breadth has improved to almost a two-year high. The consensus forecasts for F2012-14 growth stand at 11% and 15% for FY13(E) and FY14(E) respectively.

In a world that is grappling with issues to its financial existence, India offers a sweet spot in terms of its revived mien on growth and governance. The story has shifted gears and would remain on the forefront for the global investors.

As the New Year sets in, India story is benefitting from all the three ingredients of an equity market - fundamentals, sentiments and liquidity. We believe that investing environ for Indian equities has bottomed out. Market at 16xFY13E is in fair valuation zone. The policy step-through has generated enough positive reflexivity on sentiments. The market is well-poised to provide opportunities for both tactical and directional investors to participate in their respective strongholds.

Patience is the virtue that often rewards big time. Investors with patience and belief in equities have now seen sizeable positive returns in the last three years. The story rests on strong foundations of sustainable, predictable growth – a scarce commodity in investing world today. Any global stress on commodities would

enhance India's prospects further. We feel long-term investors would continue to benefit with their equity exposures at such an opportune time.

We have re-engineered our portfolios to accommodate the deserved aggression while remaining committed to core strategy of investing in quality (business, earnings, cash-flow and management) to benefit from any volatility driven by external factors. Concurrently, we have embraced tactical flexibility to accommodate exposures to businesses/ companies which offer value opportunities in a trending market.

The RBI mid quarter monetary policy review in December 2012 reinforced the guidance for additional easing in the last quarter of the current fiscal year. In a significant change, the RBI has guided that in view of the anticipated softening in inflation trajectory, the monetary policy stance has to shift towards addressing growth concerns going forward. The liquidity conditions tightened during the month of December with the buildup of government cash balances and seasonal factors leading to the deficit staying above the RBI comfort range. The RBI had announced the resumption of OMO purchases in the last week of November with the first auction scheduled in the first week of December. Government bond yields moved lower post the announcement and the benchmark ten year security traded in the range of 8.15% to 8.17% in the first half of the month. The RBI conducted OMO for Rs 40,000 crores during the month as against the primary market supply of only Rs 36,000 crores. Continuing OMO purchases, a dovish RBI guidance holding out prospects of rate action in the January review along with the government reiterating the commitment of maintaining the revised FY13 fiscal deficit target of 5.3% kept market sentiments upbeat. Government bond yields softened further in the last week with the 10yr yields closing at 8.05%. AAA corporate spreads marginally widened over the month and ranged around 72 bps in the 5 to 10yr segment.

The year 2012 witnessed the RBI commencing monetary easing by reducing the CRR by 175 bps and the repo rate by 50bps in April 12. Elevated headline inflation numbers, reversal in the deceleration in core inflation since April and the lack of fiscal policy reforms constrained aggressive rate actions subsequently. The policy focus has been to actively manage liquidity deficit conditions both through CRR and OMOs. The RBI bought back securities worth Rs. 1,81,671 Crores through OMOs in the calendar year apart from secondary market purchases in the first quarter of FY13. Money market rates have moved down structurally in the second half supported by general improvement in liquidity and restrictions on CD issuances. Recent macro data and the RBI policy guidance in the last review have resulted in market anticipation of monetary easing in 2013. The recent trend of moderation in core inflation trajectory and government commitment on fiscal prudence could lead the RBI to reduce policy rates in the January review. We maintain a positive view on bonds, especially the government securities from a medium term perspective. The possibility that the RBI may have to continue with Open market operations to ease liquidity considering the seasonal tightness in the last quarter apart from the prospects of rate easing provides an attractive investment backdrop in gilt and long term income schemes.

There could be volatility driven by global or domestic factors, however, we recommend investors to maintain the discipline of asset allocation. Both Equities and bond markets are throwing interesting opportunities as we enter into 2013.

Navneet Munot

CIO – SBI Funds management Private Limited

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

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