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June 2014

India elected its Prime Minister with unprecedented majority for the ruling party witnessed first time in last 30 years. The government has swiftly flung into action. The message on governance is clear with a smaller and younger cabinet, strategically consolidated ministries, and execution checklist that concentrates on immediate deliverables. The leadership has given right signals to both the domestic as well as international stakeholders in India’s socio-economic progress. The statesmanship to involve SAARC neighbors in the oath ceremony also has demonstrated the intent to seize trade initiatives in the region.

On ground, we expect the government to build serious momentum on ensuring better governance, fiscal discipline and execution machinery. The new government will focus on clearing the execution logjam and creating “feel good environment” which can help reviving the investments. While some of the critical reforms like dealing with labour laws, land acquisition and selling loss-making PSUs may take time, there are several low hanging fruits like resolving the Coal and iron ore mining issues which can have positive consequences. This should initiate an impulse of positive reflexivity which in medium term enables revival of the investment cycle earlier than expected.
With structural growth drivers firmly in place, a decisive and determined leadership can unleash the entrepreneurial spirit and take the growth potential to the next level. We expect coordinated continuum in fiscal and monetary policy as both government and RBI would like to anchor inflationary expectations.

Globally, the environment is factoring a better performance of the developed world over 2HCY 2014. While the tapering by US Fed has been absorbed, the markets would remain buoyant to any further liquidity release from Euro zone and Japan. In a world full of uncertainties and searching for growth, India remains in a sweet spot on account of its promise to begin a journey where growth is set to mean revert sooner. From just being a highlight of Emerging market investor set, India can become a favored investment destination of global portfolios as well as FDI flows. Domestic investors have been either exiting or absent from the equities in recent past. As equities begin their sustainable recovery phase, we expect a gradual rise in domestic savings into productive financial assets. This should provide further legs to the current rally. These accelerated flows can act as a dual catalyst – providing a case for further rerating of India and concurrently providing growth capital that can sort some of the issues in stressed sectors of corporate India.

Market valuations are in line with the historical averages but we believe that a large section is still using a rear-view mirror rather than looking forward to the possibilities. The estimated earnings CAGR for FY-14-FY16 stands at 15%. Corporate earnings are most elastic to changes in real growth; we believe as real growth picks up, earnings will see upgrades and capital efficiencies will expand. An improving earnings outlook, rising Return on equity and falling cost of capital should drive a more sustained valuation re-rating.

In the short term, the anchor on-ground shifts to, progress of SW monsoon and the pre-budget interactions of the government.

While retaining our belief in bottom-up stock picking as the best option to deliver long term results for equity investors, we have proactively been expanding our coverage universe to benefit from the valuation gap that exists down the market cap curve for the same quality. There has been a tactical tilt of increasing weight of cyclicals into our portfolios. We are increasing our intensity of engagement in sectors and companies that stand to benefit from - industrial recovery, improving agronomy, consumption enablers, manufacturing exports and new-gen aspirational opportunities at the bottom of the pyramid.

The RBI maintained status quo on policy rates as expected in the Bi-monthly policy statements. Over the last quarter, the RBI monetary policy framework has been guided by the Dr. Urjit Patel Committee recommendations. In line with the same, the RBI has expanded the Term repo facility and simultaneously reduced the Export credit refinance facility available at the repo rate. The cut in SLR by 50bps, which can also be seen as part of a medium term market development measure is intended to reduce the pre-emption of bank reserves. This would enable the banking system to fund the credit needs as investment recovery picks up. The near term impact of the SLR cut may not be material as the banking system SLR remains much in excess of the regulatory prescription of 22.5% of NDTL.

While the RBI guidance maintains the disinflation glidepath of 6% CPI by January 16, policy stance seems to have been conditioned by expectations of supply side initiatives and policy reforms on the food supply chain along with better quality fiscal adjustment by the government. A stable to appreciating bias in the currency also is expected to offset some of the negative spill-over effects on inflation due to possibility of adverse weather or any other geo political uncertainties. Even as the central bank has held out the scope for potential rate cuts if disinflation trend is faster than expected, the base case scenario remains for an extended period of pause in policy rates.

Market momentum has remained positive over the last month, with strong FII debt flows continuing post the election results. FII net debt flows were about Rs 201 billion last month, with strong flows seen in the Gilt category since the election results. FII interest has been reinforced by the strong election mandate and a stable currency even as in the context of soft global rates, the yield spreads remain very attractive. In the near term, this positive momentum helped by the relatively more neutral / dovish stance of the RBI as perceived by the market may prevent any sharp uptick in yields. Macro fundamentals especially relating to external sector have improved significantly over the last few months even as core CPI has trended lower. A directional move in bond yields would be dependent on a more consistent and durable easing in CPI inflation and also the fiscal stance. The Union Budget to be presented in July would provide better clarity regarding the prospects of medium term fiscal deficit trends and the likely market borrowings for funding the same.

Globally, the bond yields have been softening across developed and emerging markets. With the decisive political mandate, the view on rupee has turned distinctly positive. We expect foreign flows to continue given the relative attractiveness of bond yields and an appreciating currency. We have increased duration considering the changed dynamics post the election results and the global environment. We would remain alert to any material changes in market stance and also 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, for a more directional duration stance.

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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