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January 2015

Equity markets had a stellar year in 2014 with Sensex delivering 30% while BSE mid cap and BSE small cap index were up 55% and 69% respectively. The rally took a breather in December following an impasse in the winter session of the Parliament and negative newsflow from other emerging markets.

Oil prices continued to fall with brent moving below $60 per barrel. The government has smartly increased the custom duty on crude imports and excise duties on fuel products that will help bridge the fiscal gap. Lower outgo on fuel by consumers should lead to higher discretionary spending on other items as well as increase in savings.

While declining commodity prices will benefit our economy at the macro level, they also reflect the state of the global economy. It will be hard for us to grow exports in a weak global economy. Revival in the private sector capex is still sometime away. The fiscal leeway is quite limited so the government has to focus on creating an enabling environment for pushing infrastructure investments. Banking system is also constrained in terms of its capacity to fund long tenor projects hence the importance of attracting foreign investments from every conceivable source as well as boosting domestic savings which is channelized into the financial instruments. One of the main agenda of this government seems to be improving the “ease of doing business” which we believe will go a long way in unleashing the true potential of the economy. India has a real opportunity to capitalize on lower commodity prices and stand out in a world that is struggling with anaemic growth.

Given the deadlock in the winter session of the parliament, the government announced adoption of ordinance route to press ahead with the reforms. Government’s decision of exercising ordinance route to push through some of the pending legislations on coal allocation, land acquisition and Insurance, highlights that it means business. The government is shifting towards EPC from PPP model to revive investments in the road sector while the transmission and distribution (T&D) segment within the power sector is seeing renewed activity. We are seeing defense procurement gaining traction after a long time while the railway ministry is putting right things in place to revive investments in the sector. The bigger hope we have is from state governments where each state is trying to outdo each other in terms of reforms to attract investments as well as pushing the envelope on infrastructure spending. The Jan Dhan Yojana has been highly successful with over 10 crores new bank accounts getting opened up. Apart from the fruits from financial inclusion, this would also help in subsidy rationalisation through speedy roll out of Direct benefit transfer (DBT).

The ability of the government to deliver and eventually revive economic growth, trajectory of inflation and interest rates and trend in corporate profitability will be the critical factors to watch out for in the year ahead. We witnessed record FII flows of close to USD 40 billion across equity and bond market in CY 2014. Barring any adverse global development, India should continue to attract global capital given the incremental fundamental change in terms of improving macro, possible rate cuts and a definite positive policy momentum. Sustained momentum of local investors would provide further liquidity to the markets.

Though mid and small cap indices have run up more and are trading at valuations richer than large caps, we believe, they stand to gain disproportionately in an environment of improving macro, declining input and interest cost and favorable eco-system (Government’s focus on “ease of doing business”, access to capital, advances in supply-chain, technological enablers etc). While keeping an eye on macro developments and identifying emerging themes and shifts, our greater focus remains on bottom up stock picking, which we believe, is the best way to generate alpha on a sustainable basis.

Over the last year, inspite of policy rates remaining stable after the hike in January 2013, bond yields have moved lower by about 100 bps helped by improving macro situation, especially on the inflation outlook, policy credibility, stable government and substantial FII flows which amounted to over USD 26 billion. The downtrend in yields has also been supported by weaker demand situation as reflected in slow credit off take. Most of these factors are expected to support bond yields currently, even as FII flows could remain hostage to global risk appetite.

The macro data points released over the last month continues to provide encouraging signals on the inflation outlook. The CPI data for November-14 came in at 4.38% y-o-y as against 5.52% y-o-y the previous month. CPI data prints are likely to move up over the remainder of the fiscal year as the positive base effect wears off. Significant fall in crude oil prices continues to augur well for the inflation and fiscal positions given that India imports more than 80% of its oil requirements. Based on current trends, the uptick in inflation as the base wears off, would not be material, with the readings likely to be within the RBI glidepath targets.

The key theme for markets as we settle into the new year would be the expected trajectory of policy rates with recent soft CPI readings and subdued commodity prices improving the inflation outlook substantially. With a subdued credit off-take and improved liquidity, banks’ demand for government securities is likely to remain healthy in the very near term. With the market incrementally looking at change in RBI stance, supported by CPI printing below the glide path, the bond markets should remain reasonably well bid in the near term. The government has been maintaining its Fiscal deficit target at 4.1% of GDP for this financial year, in spite of revenue shortfalls and lack of progress in disinvestment program so far. We expect that in spite of a challenging fiscal position, slippages are unlikely on account of subsidy savings, expenditure rationalization and possible deferment, large opening cash balances as well as potential big ticket disinvestment proceeds over the next few months.

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 in the first half of CY15 once more data points validate a medium term soft trajectory for CPI inflation.

The RBI stance along with fiscal consolidation measures provides a sound footing to revive growth in a non-inflationary manner with macroeconomic stability. Overall we would be inclined to maintain high duration within the overall risk-return template of each fund. We are maintaining a higher exposure to government bonds in our long term funds as we believe the G-Sec market offers better value relative to corporate bonds given the tightening of credit spreads. We would be watchful towards opportunities arising out of any widening in credit spreads and also the overall portfolio liquidity at an aggregate level.

Navneet Munot

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