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May 2013

April was dominated by global undercurrents on equities, weaker commodity prices and expectations on domestic monetary easing. Sensex delivered 3.5% over the month and closed the gap in both absolute and relative terms, finishing the month as the second-best emerging market. 
The global environment remained volatile. Economic indicators in key developed economies were soft. China’s 1Q GDP print disappointed. Global commodity prices corrected sharply as a result. The sustained commitments of the leading central bankers towards liquidity provided the necessary undercurrent.
The correction in global commodity prices is expected to provide a big relief to India’s muddled macro. The policy environment remains challenging though. Some of the policy initiatives like clearance of pending approvals in oil and gas and power sector and sugar decontrol provided sustenance of the reforms momentum. However, the first week of the current Parliament session was stalled by the opposition due to the ‘Coalgate scam’. As India enters the election season, the outcomes would remain critical for Government’s ability to navigate its proposed commitment on reformist policy regime. Thus far, it has managed to tide over the tight rope walk of passing the fuel price increases.
Economic data on growth and Inflation remained optimistic. Feb IIP growth at 0.6% yoy surprised positively but was largely driven by the volatile capital goods segment. March CPI print at 10.4% yoy was lower-than-consensus expectation. WPI inflation at 6.0% reached a 40-month low. Core Inflation eased to 3.4% yoy. Growth indicators were weak but outperformed beaten down expectations. Lower inflation, sharp fall in global commodity prices and weak growth indicators revived hopes on monetary easing from the RBI. Rupee appreciated 0.8% over the month due to favorable outlook with falling global commodity prices and proposed stake hike by Unilever in its Indian subsidiary.
Foreign investors continued to remain net buyers though the pace of inflows moderated over the month. YTD, FIIs have invested US$11.5 billion while domestic institutions remained sellers to the tune of US $ 7 billion. We expect selling by domestic investors to ease off from hereon. 
The current earnings season has posted mixed results. Reported earnings for large cap companies have been in high-teens. Consumers and private sector banks have reported better-than-expected earnings, while IT Services and Industrials have disappointed. The Consensus earnings estimate for the broad market stand revised up by 0.2% and 0.1% for FY14E and FY15E over the month. The street now estimates earnings growth of 14% and 15% for FY14 and FY15 respectively. The breadth of earnings revisions though remains negative. Consumer Discretionary, financials and telecom have witnessed upgrades while materials, IT Services and Industrials estimates witnessed downgrades.
The market has displayed remarkable resilience to every adverse data point. It has almost recovered most of its recent losses at the top-end. The recent corporate activity on Hindustan Unilever and Jet Airways has certainly awakened the market. It only substantiates the theme of strategic premia that domestic franchises deserve in India as already demonstrated by similar earlier deals from Diageo (with United Spirits) and GSK Consumer. These events further complement the India story when it comes to relative attractiveness in a world slushed with liquidity and dry on opportunity.

We continue to persist with our belief on the core India story of demographic dividend, information economy, export attractiveness, supply side investment opportunities, and a proven long term DNA of economic development.  We remain unilaterally positive on the India story with the breadth of opportunities it provides at near average valuations (at ~14.5xFY14E).

We remain committed to invest in opportunities that the market offers in terms of business quality (business model, management, earnings, and cash-flows), remodeling (operations, resources, balance sheet) and valuations. 

In the Annual Policy Review on May 3, the RBI reduced the repo rate from 7.50% to 7.25% while keeping CRR and SLR unchanged. Even as RBI cut rates in order to address increased risks to growth, its forward guidance reiterated that there is little space for further monetary easing.  The baseline projection for GDP growth has been estimated at 5.7% and the average FY14 WPI inflation at 5.5%, with a focus on attaining March 14 inflation to a level of 5% using all possible instruments. The other notable change in the guidance pertains to the requirement of monetary policy to be vigilant towards the level and financing of the Current Account Deficit (CAD) which may warrant a swift reversal of the policy stance. 

The RBI policy action remains consistent with the previous guidance where the RBI had stressed on supply side responses to revive growth and also the risk from CUrrent Account Deficit (CAD) that may constrain aggressive rate actions. Recent macro data and developments related to the movement in commodity prices have reinforced the pattern of growth moderation and reduction in inflationary risks. The gradual correction in administered prices and resultant fiscal improvement, slowdown in both developed and emerging markets, lagged impact of tight monetary conditions and negative output gap reducing pricing power could lead to continuing moderation in inflationary expectations. This should provide elbow room for policy rate actions in the coming month. Additional policy actions are likely to be largely data dependant and  incremental in nature in the absence of any significant external shocks. The absence of CRR cut suggests that OMOs would be the preferred response to addressing the liquidity deficits. This should ensure that bond yields stay supported with a gradual downward move over the year in response to rate actions and macro data.

Government bond yields rallied significantly in April with the 10-year benchmark yield declining by 23 bps to 7.73% supported by weakness in commodity prices and rates positive macro data points. Yields also rallied on the back of a government announcement of a reduction in Withholding Tax for FII investors from 20% to 5% on interest income from Rupee denominated government and corporate bonds. The duration funds had increased exposure to corporate bonds during March due to higher spreads and relative favourable demand supply equation over this quarter. Over the last month, with soft macro data reinforcing market expectations of RBI policy actions, the bond yields moved lower across the gilt and bond space, with AAA spreads tightening from the levels in March. We have subsequently increased Gilt exposure as the likelihood of OMO purchases and softness in key macro variables could keep market expectations of rate easing intact. Short term money market rates moved lower post the quarter end and are likely to remain stable at current levels, with the evolving liquidity situation influencing the near term direction. 

Navneet Munot
CIO – SBI Funds Management

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