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November 2013

October witnessed fresh flows into emerging markets in general and India in specific. Buying from foreign investors resulted in Sensex closing almost near its life high giving 9.3% returns over the month. In dollar terms India outperformed its peers for second successive month.

Equities and other risk assets gained while US Dollar and commodities weakened as the drama over the US budget impasse came to an end, at least for now. Appointment of Janet Yellen as US Fed chair was perceived as another positive for markets given her dovish stance. It’s ironical that equity investors cheer poor economic data as that confirms continuity of easy liquidity by central banks. Ultimately, it is the economic and corporate fundamentals that should dictate valuations and not central bank’s actions alone. Though, one may argue, liquidity can influence fundamentals and markets are reflecting it.

At home, the government continued to creep with its commitment to get growth on track without compromising on its reforms agenda. Government cleared buyback plans of cash rich PSUs, capital infusion into the PSU banking system and also an active consideration of higher fuel prices to reduce subsidies burden. As the monsoon recedes, the onset of state elections now is set to dominate the political actions and economic environment.

Macro economic data points released over the last month were mixed with growth data continuing to remain soft while inflation data was higher on account of food inflation and currency depreciation. Unlike the trend over the past one year, core inflation has recently started moving higher in tandem with headline inflation and this is something that needs to be monitored closely. IIP y-o-y growth for Aug 13 was also lower at +0.6% compared to previous month growth of +2.8% y-o-y (which was revised from +2.6%). On the trade front, the trade deficit narrowed sharply to USD 6.7 billion in September from USD10.9 billion in August. The rupee appreciated by around 2% against the US Dollar over the past month and ended the period at 61.5 on the back of improved sentiments.

The early part of current earnings season has been a breather against initial expectations. Adjusted profit for large cap companies grew 12% yoy. So far, IT Services, Financials and Consumer Discretionary have delivered positive surprises while Cement, and Consumer Staples have failed to inspire. Global sectors - IT services, materials, healthcare and energy have seen earnings upgrades. The valuations though have inched above average through the last month performance.

Continued momentum in foreign fund inflows, policy actions and earnings beat helped markets scale a new high. Improvement in Current account and signs of some stability in Rupee has helped sentiments. For a comparison, in US$ terms, our market cap is 40% lower compared to the previous high in 2008 and market valuations are 40% and 60% inexpensive in forward P/E and P/B terms. External environment has though changed materially to India’s advantage.

Next few months are likely to witness arrival of winter crop in the market, election related spending and seasonal acceleration in growth momentum. The market performance in near future would be dependent on corporate earnings season, peak festive season consumer sales, political maneuvering during the winter session of parliament and the state election results.

As things stand, India story stands at an interesting crossroad. India is endeavoring to revive the lost glory with sustenance of consumption, resurgence of exports on the back of improved competitiveness (with recent currency depreciation), and implementation of a healthy infrastructure template, post 2014 elections. Lack of plausible, investible opportunities in the Emerging market peer-set also makes it a destination for long term global return seekers.

We maintain a bias towards growth and quality while remaining tactically alert to opportunities from volatility that gets induced by global events. We remain committed to unearth more high conviction stock ideas from our research when the rally gets broad-based.

The RBI continued the process of normalizing the conduct of monetary policy with a cumulative 75bps reduction in the Marginal Standing Facility from 9.50% to 8.75%, while simultaneously hiking the repo rate by 25bps to 7.75%. With the additional access under term repo of 7 and 14 days and Export credit refinance, the recourse to funding under MSF is expected to gradually reduce. This should allow short term rates to gradually ease and align with respect to the Repo rate in the absence of significant additional currency withdrawals from the banking system in the coming months. With the RBI stressing on enhanced efforts to mobilize deposits as a durable strategy for mitigating mismatch of funds, it can be expected that the central bank is unlikely to revert to unlimited overnight funding under LAF in the near term.

The policy stance continues to be guided by the consideration of anchoring inflation expectations and curbing inflationary pressures as a prerequisite to maintaining macroeconomic and financial stability. The hike in the repo rate must be seen in the context of continued focus from recent RBI statements on increasing financial savings, which would strengthen the foundations for growth. Towards this objective, issuances of CPI linked savings securities for retail investors would commence from Nov/Dec 2013. The policy stance continues to be neutral with the evolution of inflation trajectory likely to influence additional moves on the repo rate. The reduction in MSF rate has led to a sharp rally in the front-end of the curve and the treasury and AAA credit curve has steepened considerably. AAA corporate bond spreads were tighter by around 15 bps over the course of last month.

The developments over the last couple of months and the changed RBI stance, with an emphasis on containing inflationary expectations has reduced the possibility of a near term downward trend in long term yields on a directional basis. In the backdrop of soft global yields, likely easing in domestic liquidity and still moderate growth, long end bonds may continue to attract sporadic buying interest at higher levels. This may also be helped by prospects of Indian gilts being added to global bond indices. The trajectory of inflation, especially the Consumer Price Index may determine further moves in the Repo rate. Overall, in view of the renewed focus on inflation, further policy hikes cannot be ruled out, with the extent and sequencing likely to be moderate and gradual in view of the disinflationary impact of below potential growth.

The likelihood of Forex reserve accretion through the NRI deposits and higher provision of term repo borrowings may obviate the necessity of the RBI conducting large scale OMO purchases. However as evidenced from the RBI recent press release, the central bank continues to actively consider OMOs to provide adequate liquidity and may also look to do so largely in the front end of the curve. The front end of the curve looks relatively attractive in the current situation while long bond yields are likely to remain range-bound with a marginally upward bias.

Navneet Munot
CIO – SBI Funds management Private Limited

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