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March 2015

While the European central bank (ECB) and Bank of Japan (BoJ) are likely to pursue aggressive quantitative easing, the US could be getting closer to the beginning of a normalization of monetary policy, given the continuous improvement in its labor market. The US dollar has appreciated against most of the currencies, having a disinflationary impact on the US while negatively impacting profits of its companies deriving revenues from the rest of the world. Bond yields have touched ultra-low levels (near-term yields in most of the developed world are in negative zone) and the liquidity glut has benefited most of the other asset classes. Though the tentative agreement of Troika with Greece has provided a relief for the next 4 months, a lasting resolution to the problems in the Eurozone periphery would not be easy given the political polarization. Though, we must add, sharp weakness in Euro is likely to help improving the competitiveness of the Eurozone. The global environment has been positive for India in two major ways; soft commodity prices have helped in improvement of macro indicators across the board and foreign investors continue to pour money given the relative attractiveness of India. As we expect volatility in global markets to inch up, could it affect India? Yes. We hasten to add, given the improved macro situation, a stronger external sector balance sheet (forex reserves at record high) and better policy climate (with a decisive leadership), impact on India is likely to be relatively muted. Increased faith in financial assets among domestic investors would also act as a cushion in case of any external vulnerability.

Sensex touched a record high during the month buoyed by improving macro data and a benign liquidity environment. Markets were keenly awaiting the presentation of the Union Budget for further direction. We believe that the budget should be read in conjunction with the Railway budget, reports of the 14th Finance Commission, Expenditure commission (to rationalize government expenditure), NITI Aayog (replacing planning commission) and the new template of infrastructure development and natural resource allocation. Both the Railway and Union budget clearly indicated Government’s focus on increasing the allocation towards infrastructure. Flaws in the PPP model have been acknowledged with the willingness on the government’s part to enhance clarity of contracts with a proper redressal mechanism and also a greater risk-sharing by the sovereign in infrastructure development. The ongoing coal mines auction and spectrum auction reflect the success of a new, transparent way of allocating natural resources. We re-iterate that state governments will play a bigger role in economic development in this new era of co-operative federalism’. They will have more resources at their disposal, a helping hand from the Centre and more importantly, willingness to carry out structural reforms to attract investments (the labour reforms in Rajasthan are likely to be replicated by other states).

The Government’s intent and efforts on financial inclusion will have far-reaching implications. These will give a boost to domestic savings while ensuring its channelization into productive investments. Measures for financialisation of real estate and for the gold market can potentially transform the savings and investment patterns. These, along with measures to discourage black money creation and promotion of digital finance could put the “parallel cash economy” on a permanent descend while improving the tax to GDP ratio.

The government is clearly making efforts on improving the ‘ease of doing business’ with a genuine effort on simplification of not only the tax regime but overall regulatory regime for all stakeholders in business. As the rules of the game change, businesses with operating mindset of ‘yesterday’ may face the heat while extra ordinary opportunities will arise for those who have the vision, integrity and execution capability to win in this new environment.

While we maintain our long term positive outlook given the structural and cyclical improvement in the macro, softer interest rates and better business climate, we expect markets to consolidate its gains in the near term. Major move in the market over the last year has been driven by valuation re-rating and further gains will track earnings growth, in our view. We also expect equity issuances to absorb good part of the incremental flows helping the market to take a breather in the near term.

The RBI announced an inter-meeting rate cut of 25 bps (taking the Repo Rate to 7.50%) on 4th March. It factors in RBI’s assessment of the fiscal consolidation measures announced in the Union Budget, global trend towards monetary easing and also the slack in the economy, which is at variance with the revised GDP numbers. The RBI has assessed the quality of fiscal consolidation to be better both in terms of the intent as well as the projections. Even though the targets have been deferred by a year, the quality of consolidation has been assessed to be better. The comfort from the fiscal numbers arises from the following facts:

· Realistic revenue side projections and attempt to clear the legacy issues such as deferment of expenses leading to a higher amount of consolidation than implied by headline numbers

· Focus on better targeting of subsidies via Direct Benefit Transfer

· Focus on infrastructure investment for sustainable growth and a higher transfer to states which may lead to consolidated fiscal deficit moving lower

The policy rate reduction has been conditioned by the requirement to act in a pre-emptive manner once the available data and macro fundamentals provide the necessary space. With CPI inflation undershooting the glide path targets, soft commodity price expectations, better quality fiscal consolidation and the global monetary easing environment, the space for required monetary easing had opened up.

While any volatility in the global markets could also affect our bond market, the impact is likely to be much muted compared to the experience in 2013. The differential between bond yields globally and Indian yields is very wide and adjusted for volatility in our bond/currency market as well as the CPI trajectory, Indian bonds are likely to remain attractive for global investors.

Going forward, with the revised Monetary Policy Framework signed recently with the government, the RBI policy stance would be dependent on the objective of maintaining CPI inflation at 4% over the end of two year period starting in fiscal 2016-17.
The Inflation targeting framework instituted in the Monetary Policy framework would entail that the hurdle for aggressive monetary easing moves higher. Recent developments on the inflation outlook provide reasonable confidence of medium term inflation closer to 5.0% to 5.5%. With the stated comfort of the central bank on a real policy rate in the range of 1.5% to 2.0%, the expectations of a terminal repo rate in the range of 7.0% to 7.25% seems achievable, at this stage. Continuation of favorable inflation momentum, continuing progress on fiscal consolidation and supply side reforms could provide space for additional cuts. We have been maintaining relatively high duration in our bond funds in view of positive outlook on interest rates.

Navneet Munot

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