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November 2014

And  then  came  the  Japanese!  As  the  Quantitative  easing  (QE)  program  of  the  US  Federal  reserve  got unwound, came a surprise boost of liquidity from Bank of Japan. It’s a bold move from the Bank of Japan to combat deflation. Japan’s public debt is estimated at 225% of its GDP and the central bank is determined to achieve its target of 2% inflation; however, the 10-year government bond trades at a yield of 0.45%. Japan’s largest  pension  fund  (GPIF)  has  announced  its  intention  of  substantial  increase  in  allocation  to  equities including foreign equities. Stocks zoomed while the Yen fell to a 7-year low.
 
After  a  surprise  rate  cut,  the  European  central  bank  (ECB)  is  moving  closer  to  some  form  of  quantitative easing. At some point, austerity may be shown the door as Eurozone struggles to get  growth back. Election results  in Brazil,  the  geopolitical  situation  in Russia and concerns about  China  and other emerging markets have  led  to  outflows  continuing  from  emerging  market  funds.  They  are  also  impacted  by  the  continued strength in the US dollar and soft  commodity prices. India has been an exception as it  remains the biggest beneficiary of the fall in global commodity prices, from a macro perspective. India is now a consensus trade in the world on the back of a stabilizing macro, possible revival of growth, diversified investible options and reasonable relative valuations (both historic as well as comparative).  The equity markets scaled a new high and closed 4.86% higher over the month. India is today the second best performing emerging market in its peer set for the year.  
 
Rupee  appreciated  0.8%  during  the  month.  We  maintain  our  view  that  in  an  environment  of  a  stronger dollar globally and with RBI determined to increase forex reserves, the rupee is likely to stay under pressure despite robust capital flows. But, it should perform relatively better than its peers.  

With  assembly  elections out  of  the way,  the  government  stepped  up  the  reform  process.  Some  of  the  key measures  taken  include  -  deregulation  of  diesel  prices,  hike  in  natural  gas  prices,  minor  labor  reforms, ordinance  on  coal  block  auctioning,  easing  of  FDI  norms  in  the  construction  sector  with  emphasis  on
affordable housing and a cut in the non-plan government expenditure. There are expectations on legislative actions  such  as  the  constitutional  amendment  for  introduction  of  GST  in  the  coming  winter  session  of Parliament. We firmly believe that India is unfolding its structural story in this phase of its economic growth. The new regime is slowly but steadily pushing the envelope in terms of necessary reforms and policies that can  improve  “ease  of  doing  business”.  There  is  a  gentle  permeation  of  accountability,  transparency  and efficiency  through  all  the  critical  layers  of  governance  which  should  gain  permanency  over  the  medium term.
 
While  some  monthly  economic  indicators  have  slowed  from  July-August  highs,  early  signs  from  the  festive sales  indicate  that  consumer  confidence  is  rising  and  should  drive  positive  demand  surprise  from  the December quarter onwards. Urban consumption indicators seem to be doing better than rural consumption.  
 
The  opportunity  of  growth  in  India  remains  immense  with  multiple  themes  that  revolve  around  changing governance,  changing  consumer  preferences,  changing  technology  and  changing  ownership  patterns.  Each of these variables over the medium to long term possesses disruptive  traits that  can challenge  the current market  structure.  Therefore,  the  new  winners  of  this  story  will  also  be  different.  We  remain  believers  in investing   themes   such   as   branded   franchises,   manufacturing   outsourcing,   consumption   enablers, beneficiaries  of  changing  technology  trends,  and  innovation  led  growth.  We  also  expect  a  revival  in  the
investment  cycle  driven  by  infrastructure  spending  followed  by  private  capex  at  a  later  stage.  We  are confident  that  our  incessant  focus  on  research  driven  investing  allows  us  to  focus  on  separating  these strands to bet on the right businesses and management that would enable us to identify these opportunities early enough to ride the entire wave.  

The pressure is mounting on the Reserve Bank to soften its stance on monetary policy given the better-than -expected CPI reading, fall in global commodity prices particularly crude oil, poor credit growth and weaker manufacturing  data.  The  government  has  been  showing  a  commitment  of  doing  its  bit  through  marginal increase  in  minimum  support  prices,  cut  in  diesel  prices,  pushing  direct  benefit  transfers  (DBT)  and announcing fiscal austerity measures to keep deficit under check.  The new government has stuck to giving low  Minimum  Support  Price  (MSP)  hikes  and  keeping  freebies  in check.  As  against  the 7%  and 9%  average MSP  hikes  for the  last 5  and  10-year  respectively, the  government  has  announced  a  minimal  4%  MSP  hike this year. This augurs well for containing food inflation and subsidies.  
 
Bond yields and swap levels have declined sharply with expectations of the RBI stance undergoing a change. The  benchmark  10-year  bond  yield  has  fallen  to  a  level  of  8.25%,  lowest  since  September  2013.  The  yield curve  has  flattened  substantially  with  long  term  bonds  performing  far  better.  Foreign  investors  have pumped  in  a  record  $  22  billion  in  Indian  bonds  this  year.  With  their  limits  for  sovereign  bonds  getting exhausted, demand for corporate bonds has gone up resulting in credit spreads contracting to record lows. The global deflationary environment as reflected in ultra-low bond yields in the rest of the world has led to aggressive  bidding  by  foreign  investors.  India  offers  a  high  carry  with  expectations  of  relatively  stable currency and a positive turn in the monetary policy cycle.
 
Our view has been that it may be a while before RBI considers monetary easing in the backdrop of the new monetary policy framework. However, looking at the CPI data, the global environment, views expressed by members of monetary policy advisory panel and actions by the government as outlined above, possibility of RBI softening its stance has gone up. RBI has announced open market sales of government bonds to suck out excess  liquidity  and  maybe  to  tame  the  rally;  however,  underlying  momentum  remains  bullish.  With  a subdued credit off-take and improved liquidity, banks’ demand for government securities is likely to remain healthy in the near term.  
 
We have increased duration through exposure to government bonds in our long term funds. We believe the G-Sec market offers better value relative to corporate bonds as credit spreads have tightened substantially. We  also  have  a  small  exposure  to  Inflation  Indexed  bonds  (IIB)  which  at  4%  real  yield  offers  good  value regardless of directional views on the trajectory of inflation.  
 
 
Regards,
Navneet Munot

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

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