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.
The 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
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