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November 2012

October began with high expectation on the backdrop of strong momentum of the previous month. The benchmark index Sensex finally settled lower (-1.4% m-o-m). YTD, India slipped to be 8th best performing market in its Emerging market peer set (5th last month). News flows from developed economies were not supportive of riskier assets’ performance. Quarterly earnings season in the USA failed to boost investor confidence. Economic indicators from the Euro area were mostly disappointing. 

In India, the monthly data on growth and inflation continued to remain disappointing. IIP growth for August came higher than expected at 2.7%. The beat however was led by the volatile capital goods sector. WPI inflation increased to 7.8% in September, driven by hike in retail diesel price. Core inflation remained unchanged at 5.6% but its sequential acceleration remains concerning. 

Against wide expectations of initiation of accelerated policy rate-cut cycle, RBI cut the CRR by 25 bps and left benchmark rates unchanged. The tone remained hawkish. The Central bank hinted towards a potential easing in 4Q FY13 as inflation eases. The stern vigil of the monetary regulator more than negated the fiscal announcements made by the Government. The rupee too depreciated by 2.4% through the month. 

The primary catalyst for the market through the month was corporate earnings and remained more stock specific. Corporate earnings announcements for the broader market have been better than expected with more positive surprises and fewer disappointments. There is a marked improvement in most of the operational parameters. 

The government has been showing a sense of urgency to get the growth momentum back. The Cabinet announced an increase in FDI limit in the insurance companies and pension funds. These changes will require legislative approval. While Government also announced a cabinet reshuffle (with infusion of next gen lieutenants) there were some regressive steps like refarming of spectrum and proposed revision in land acquisition act. Going forward, the formation of National Investment Board (NIB) and its operative framework, progress on GST and execution from the new ministers (Railway and power to name a few) will be keenly watched by the market. 

We expect India to emerge as a stronger economy with better controls on its socio-economic quotient. The inherent anxiety in the global environment does provide further stimulus for a faster recovery on the back of softer commodity prices and an enhanced position as a sweet spot in a growth-stressed world (with higher predicted exposure in Global Benchmarks). The wired-money-network of the world does make the markets reliant on the quantum and direction of global flows. The sporadic emergence of violent volatility (the “risk-on” and “risk-off” moods) would continue to provide opportunities for both tactical and directional investors to participate in their respective strongholds. 

We firmly believe that investing environ for Indian equities has bottomed out. The inevitable recovery can never be timed precisely and hence investors who remain alert to value and committed to discipline would stand to gain through increased exposures in such environment. We have tactically re-engineered our portfolios to augment our core belief strategy of investing in quality (business, earnings, cash-flow and management) with flexibility to accommodate tactical holdings in businesses/ companies which offer opportunities to participate in a trending market. 

While foreign investors have pumped in $ 18 billion this year, domestic investors have been staying away. We maintain our positive view on equity markets and strongly recommend that investors should not remain under weight in equities. 

Despite the market belief that RBI might succumb to pressures and cut policy rates, RBI toughened its stance on inflation and maintained a status quo on rates. The RBI policy guidance has acknowledged the reform initiatives while cautioning on the execution aspects. The monetary stance of keeping rates unchanged while addressing the likelihood of liquidity stress through CRR reduction has been consistent with the recent RBI actions. The system liquidity could come under stress in the coming weeks on account of seasonal factors such as higher currency in circulation on account of festive season. This coupled with likelihood of government maintaining high cash balances and the slowdown in deposit growth have led to the RBI reducing the CRR, which now stands at 4.25%. The central bank has downgraded the FY13 GDP estimate to 5.8% from 6.5% and increased the year end WPI estimate to 7.5% from 7.00%. The recent stickiness in inflation numbers and the likelihood of WPI firming up in the coming months have weighed in on the policy stance. The RBI, has however guided that based on their current estimates on the evolution of growth inflation dynamics, there is a reasonable likelihood of additional easing in the 4th quarter of the current fiscal year. 

On the inflation front, the wage-price spiral has to be broken. It is peculiar that despite the sharp fall in industrial growth and GDP growth, corporates face labour shortage and consumer prices show no signs of moderation. The whole world is dealing with deflation while Inflation in India has become sticky. We believe that the massive increase in government consumption since 2007 without commensurate augmentation of the supply side alongwith a loose monetary policy during 2009-10 have led to inflation and inflationary expectations to rise. We need an extra ordinary push on reforms and execution that enhance the efficiency and productivity of the economy. That’s the solution to tackle inflation on a structural basis and not by killing the demand side which can lead to severe social issues later.

We have a benign view on inflation for FY 2013-14 due to output gap in India, soft global commodity prices due to slowdown in China, stable currency, lagged effect of tight monetary policy and our expectation of relatively tighter fiscal policy. This should pave the way for policy easing next year. 

RBI may have to resort to Open market operations to ease liquidity which augur well for the Gsec market. The short end of the curve should remain well supported given the demand supply dynamics and possible RBI intervention to ease liquidity in the system. In our duration funds (Dynamic and Income fund), we have increased exposure to Gsecs compared to corporate bonds as credit spreads have shrunk. Given our positive view on interest rates, we continue to recommend SBI Magnum Income Fund and SBI Dynamic Bond Fund as suitable for investors with risk appetite and horizon of at least a year. Our short term fund is rightly positioned to benefit from the further easing in short term yields. It is for investors with a moderate risk appetite and investment horizon of at least 6 months to a year. 

Navneet Munot 
CIO – SBI Funds management Private Limited 

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