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March 2014

Sensex closed higher (up 2.9% m-o-m) on the back of positive sentiments created by the pre-election surveys towards expectation of a market friendly alliance coming to power.

The global backdrop was mixed. Growth indicators out of developed markets have been relatively better than from emerging markets. A combination of weaker-than-expected economic indicators and undesired political developments kept investors cautious on emerging markets. As we write, the anchor is gradually shifting from US Fed’s tapering of QE to financial stress in China and political unrest in Ukraine.

At home, the government presented the vote-on account (interim budget), which focused on promoting consumption demand growth by reducing excise duties on automobiles and also aimed at sustaining the fiscal consolidation impetus. The government has continued with its unfinished agenda in terms of programmed fuel price hikes, spectrum auctions and technical disinvestments of large PSUs. Domestic indicators remained mixed. GDP growth for 3QFY14 was lower at 4.7% as against 4.8% in 2Q, mainly dragged by contraction in manufacturing. IIP growth was negative, with manufacturing remaining in the red for third consecutive month. Inflation surprised positively, however, core CPI remained unchanged. The necessary vigil by RBI has kept the currency stable too.

The economic agenda for the new government will include few obvious things. We need higher economic growth with focus on creation of jobs and containing inflation. Having witnessed the dark side of external vulnerability, policies will have to gear towards boosting exports/import substitution. For these three critical goals to be achieved, better governance, fiscal discipline and execution ability would be the keys. Building physical and social infrastructure is essential for increasing productivity of the economy which will go a long way in job creation, containing inflation and make India globally competitive. While legislative reforms may take time, the new government should focus on clearing the execution logjam (faster and speedy clearances for projects) which can revive the investments. Coal and iron ore mining issues can be resolved and have lot of positive consequences. Most of the recent fiscal gains have come on account of deferment of expenditure, selling the assets/higher dividends from PSUs and cutting the plan expenditure. Fiscal consolidation will have to be achieved with larger focus on cutting the wasteful expenditure particularly subsidies, broad-basing the tax revenues net and moving from a mind-set of ‘outlays’ to ‘outcome’. Both fiscal and monetary policy should be in sync to ensure inflationary expectations are well-anchored while investment climate is supported. Both these goals are inter-twined and not mutually exclusive as the debate goes.

Irrespective of the nature and form of the next government, coming elections provide India with a discontinuous opportunity to get its core components governance back on track. Around 120 million first time voters representing post reform aspiring Indians would be the key stakeholders of the outcome. Opinion polls are indicating a single party dominance in the election results. While final manifestoes of most of the participants are yet to be announced, development remains the least common denominator in political advocacy.

The 3QFY14E results season was marginally better than expected. While some of the commodity input price benefits continued, overall profit growth was at 7-8%. Management commentaries remained cautious. Divergence in performance of large-caps vis-à-vis mid-caps also continued. Mid-caps are now an attractive investment piece of the market. The sequence of downward earning revision continued. Estimates for FY14E and FY15E were reduced by 0.5% and 1.1% respectively over the month. The market now estimates earnings growth of 9.1% and 18.1% for FY14E and FY15E respectively.

FIIs have been strong believers in the India opportunity and remained marginal buyers and were joined by domestic investors in the last month. Sustained domestic flows are critical building blocks for a durable bull market. We expect domestic flows to gain motion through the year on the back of relative attractiveness of equities against other alternatives.

While maintaining a quality bias, our portfolios have been shifting the tilt from defensive to cyclicals given our belief that economic growth and corporate profitability are bottoming out. While remaining vigilant on the risk arising from political development and global flows, our focus continues on bottom up stock picking.

The bond market trends over the last month have been largely subdued inspite of rates positive data on both inflation and growth and also the end of the current fiscal year borrowing schedule. The subtle shift in the RBI monetary policy and liquidity management framework apart from overall muted investor demand has resulted in bond yields staying mostly range bound with an upward bias over the month. Even as the RBI guidance has made further rate actions data dependent, with a focus on CPI inflation, the shift towards term repo for addressing liquidity tightness has reduced the extent of potential OMOs. Seen in the context of the rather challenging borrowing schedule over the next fiscal and the fact that OMOs absorbed about 30% of the net supply over the last few years, the market uncertainty may prevail for a while or until a more definite downward trend in CPI inflation is firmly established. The benchmark 10-year Gilt yield moved up by 10bps over the last month to close at 8.86%.

Macro economic data points released over the last month showed improvement with both growth and inflation data moving in the right direction. The WPI data for January 14 registered a y-o-y growth of 5.05% as compared to expectations of 5.60% and previous month growth of 6.16%. The retail inflation index, the CPI also moderated significantly at 8.79% y-o-y for Jan-14 as against estimates of 9.20% and the previous month reading of 9.87%. Core CPI remained sticky around 8.2% in the latest data. Concerns on the external sector have receded with improving Current account deficit and a remarkably stable currency. FII debt flows have remained positive since the beginning of calendar year with increased participation at the short end.

Seasonal pressure on liquidity and balance sheet consideration have led to short term rates moving up over the last few weeks. Unlike the previous trends in Feb-March, the overnight rates have been well anchored currently with the RBI even comforting markets regarding its intention to actively conduct term repos through March. Money market rates which corrected briefly post the RBI press release have continued to firm up since on concerns regarding issuance pressure as well as weaker financial position of certain Public sector banks. We expect that the current levels provide a very good investment option for all short to medium term funds as the rates at the short end could correct meaningfully from current levels over the beginning of the next quarter.

Navneet Munot

CIO – SBI Funds Management Private Limited

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