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June 2015

The month was dominated by the high-decibel debates on “one-year of Modi Government”. The efforts of the government have been laudable in terms of a positive, irreversible policy framework resting on fairness, transparency and predictability. It has also created an environment that promotes ease-to-do business, which is authentic to support a business instead of a businessman. That’s a big shift according to us. Efforts to improve India’s credibility among global fraternity will deliver fruits over a long period. There has been a steady beginning to engulf the ‘parallel’ economy into the mainstream with subsequent incentives to financialization of physical assets. The intent and measures toward “co-operative federalism” will lead to state governments playing a stronger role in the growth process. One also expects the momentum on reforms to continue with important bills on land acquisition, labour and GST taken to formal conclusion.

The recent economic data are showing a mixed picture. Tax revenues in April have shown a quantum jump and GDP growth for last quarter came at 7.5%. Spike in crude oil and unseasonal rains have caused short term worries. Bank credit growth is at its 20-year low. Corporate results have been disappointing. Management commentaries on ground have been weak. While consensus is expecting a further improvement in the current account deficit, recent trade data suggests that numbers are unlikely to match expectations. Rupee after a range bound performance is slowly trending to cross 64 against the US Dollar. These walls of worries are with a silver lining of pick up in government expenditure in key sectors like infra, transport, defense and railways. India also stands to benefit with RBI continuing with policy rate cuts and from any correction in crude and other commodities.

The dollar strength against global currencies is a structural trend and should resume post recent technical correction. Expectations of monetary policy normalization in US against extremely accommodative stance by ECB, BoJ and other central banks should support the US Dollar. RBI has been beefing up Foreign exchange reserves and in the backdrop of a strong US Dollar, a gradual but orderly depreciation of rupee would be essential to maintain export competitiveness. Any resolution of Greece issue (though more like kicking the can down the road) may provide an interim relief rally to the global markets. The strength of stock market rally in China driven by domestic investors has surprised global investors leading to reallocation of portfolios. Growth remains scarce globally. With a positive macro and policy environment, India is likely to remain on radar for investors seeking growth and quality.

India has been a consensus trade for a while. Although, after a long time one witnessed FIIs to be net sellers in the month of May. The domestic investors continue to be buyers in the meanwhile. The recent period of uncertainties has helped markets consolidate on its dream run witnessed in the last 12-months. As the decibels increase on this pessimism, we feel we are close to the trough on sentiments. The corporate earnings would also start reflecting benefits of lower input prices, better operating leverage and lower interest costs with a lag.

Corporate earnings have been disappointing with earnings downgrades to the tune of 1.5%. As things stand, market valuations are at 16.3xFY16E and 13.7xFY17E, with an estimated growth of 17% over the next two years. Going forward, the market would take cues from trends in monsoon, global flows and government action. As spending by centre and state government picks up, we expect situation ‘on the ground’ improving at the margin.

We feel current market weakness and volatility presents a long-term investment opportunity for equity investors. We expect sustained domestic flows, coupled with reasonable valuations to provide support to the market. This stage of the market would create new opportunities with changing consumer, emerging technologies and improved policy framework.

Today’s monetary policy stance has been largely conditioned by the uncertainty surrounding the evolution of Monsoon and the possible government policy responses. The marginal upside revision in CPI estimate for January-16 to 6% factors in the possibility of a below normal monsoon. The 25 bps reduction in policy rates and a cautious tone in the statement reflect RBI’s fine balancing act between providing monetary accommodation to address growth concerns while maintaining its inflation fighting credibility in the context of near term price pressures.

The policy stance recognizes the downside risks to growth arising from decline in agriculture activity, uneven recovery in industrial production highlighted by falling capacity utilization in several segments, drag from net exports and also a mixed picture in services sector growth. The incremental policy actions would be data dependent, significant among them being the impact on prices arising out of a possible below normal monsoon. While the evolution of spatial distribution of rainfall is difficult to estimate, the eventual translation into general prices would largely be a function of government policy responses with respect to food stock management and also management of minimum support prices. Even as the central bank has flagged risks arising from the above, we remain confident of better management of food sector as in the recent year.

The formal adoption of an inflation targeting framework with a medium term inflation target of 4% had ensured that the hurdle for aggressive easing had moved up, with medium term CPI estimates determining the extent of policy easing. As evident from excess capacity and also lower pricing power, demand side price pressures are expected to be subdued. In this environment better food management as indicated by the Governor can contain food price driven inflation. With a neutral stance and also a potential near term pause, bond yields have backed up post the policy.

In the context of the current economic cycle as well as global growth environment, policy rates can move lower at least to 7.00% in the current fiscal subject to supportive fiscal policy actions. Supported by overall weak credit demand which should keep demand for bonds reasonably robust in the near term, benchmark bond yields should eventually settle lower over a period. Uncertainty surrounding evolution of near term price trajectory and also global factors would keep yields volatile. We remain alert towards any material change in the evolution of macro variables.

Navneet Munot
CIO – SBI Funds management Private Limited
(Mutual funds’ investments are subject to market risks, read all scheme related documents carefully.)