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October 2012

At a time when expectations were running quite low, the government unleashed some critical reforms and large central banks led by the US Federal Reserve embarked on another bout of quantitative easing. Benchmark Sensex finally closed 7.6% higher m-o-m. YTD, India is 5th best performing market in its Emerging markets peer set. 

News flows from developed economies were supportive of riskier assets’ performance. Fed Chairman’s announcement on QE3 boosted investor confidence. Subsequent similar initiatives by Japan reaffirm the commitment of global central bankers of creating a synchronized response to any adverse economic development. On this backdrop, developments in EU which remained relatively volatile were not unsettling to the global capital markets. 

At home, government did surprise positively with a series of initiatives including the much awaited and ever-impending hike in diesel prices, increased FDI limit for multi-brand retail and Aviation, roadmap on SEB restructuring and reduction in withholding tax. The Government seems to have successfully calibrated its actions against backlash from allies as well as opposition and has in fact stressed on its intent to go ahead with further extension of its strong stance of reforms. The higher decibel on policy rhetoric helped offset any incremental uproar on the coal allocation issue. 

Monthly data on growth and inflation continued to remain disappointing. IIP for July increased a marginal 0.1% yoy and was below expectations. Capital goods and consumer non-durables continued to deliver weak data series. WPI inflation printed higher at 7.6% in August, driven by increase in electricity prices and non-food primary articles. Core inflation increased further to 5.6%. 

When it rains it pours. The swift policy reversal, smart political navigation, astute management of investor sentiments have also concurred with higher “risk-on” flows (post QE). The monsoon obliged with a cover-up of its deficit thus far (7% against 12% at the start of Sep). The RBI announced a 25 bps cut in CRR as it left the benchmark repo rate unchanged. The rupee too has begun contributing to the reflexivity with a sizeable 5% appreciation. 

Market activity did pick up with improvement in investor sentiments, performing markets and persistent foreign flows. FIIs were net buyers with net inflow of USD 3.6 billion while domestic mutual funds were net sellers to the tune of USD 560 million. 

As we turn to October one can expect the earnings season to be a key driver for the market direction. Initial advance tax data has been encouraging and do not suggest any significant negative surprise. 

“Metamorphosis - Making of a butterfly”, is an interesting process. The desired outcome is always colorful but the process is painful. We continue to believe that the corporate India is in that phase right now when the economy is going through the cyclical slowdown. Results of next few quarters would be a litmus test of internal initiatives being taken to molting latent excesses – both in operations as well as business finance. 

The flow through of such initiatives would be good take-off preparations – when a soft global commodity environment (and the current rupee strength) turns a respite. 
A timely and politically well navigated policy reset, comparably comfortable GDP growth when its peers find themselves struggling and a near-bottom operative corporate performance make India among preferred destinations for global flows seeking returns, predictability and growth. One can expect that India has bottomed in terms of its representation of Global investing benchmarks. This should result is providing requisite liquidity cushions to the market in turn creating its own positive cycle. As things stand, liquidity is a prime factor that is contributing to the market direction. 

One must also acknowledge the fact that global flows and their increasing significance should make markets more volatile – integrating it with the Risk-On and Risk-Off moods of global capital markets. Such volatilities do provide opportunities for both tactical and directional investors to participate in their respective strongholds.

We firmly believe that such an environment should reward investors who remain alert to value and committed to discipline. While we remain firm in our core belief strategy of investing in quality (business, earnings, cash-flow and management), we remain flexible to accommodate tactical holdings in businesses/ companies which stand to benefit in the environment of easy liquidity – when it come to their business or balance sheet. 

Over the last couple of months, amidst an environment of gloom, we have been advising investors to not lose sight of the long term fundamentals and take advantage of the market downturn to build exposure to equities and long bonds. We reiterate that investors should maintain the discipline of asset allocation instead of getting swayed by the volatility. 

The RBI monetary actions to address the growth risks in the economy had been constrained by the lack of supply side initiatives and the higher fiscal deficit. The fiscal impact of recently announced measures by the government is expected to be modest at around 0.1% of GDP. The initiation of reform measures do however send out a positive signal regarding the direction of government policy. The RBI kept policy rates on hold in the Mid Quarter Review on 17th September while reducing the Cash Reserve Ratio by 25bps. The RBI, while acknowledging the recent reform measures has highlighted the continuing risks from the elevated inflationary pressures and the fiscal and current account deficits. The guidance has interestingly acknowledged that monetary policy has an important role in supporting the growth revival. 

The CRR reduction has to be seen in the context of recent actions from the RBI to ensure adequate liquidity in the banking system. We anticipate that the RBI could follow up the CRR reduction through additional OMO transactions in the coming months to ensure that liquidity conditions do not stress the banking system and credit flow to productive sectors is maintained. In the event of further reform initiatives from the government in the coming days, the market would position for the possibility of a rate reduction in the policy review in October. The INR rates and currency markets responded positively to the reform announcements. The benchmark 10-year government security yield closed at 8.15%. The AAA public sector credit spreads have tightened by around 25-30 bps in the 5 to 10 yr segment and by around 35bps in the 2-3 years segment. The applicability of new regulations governing the sectoral exposures in debt funds and the lack of supply have helped credit spreads to compress significantly. 

The second half borrowing schedule at Rs 2 lakh crores has come in line with the budgeted numbers. In spite of the possibility of slippages on the revenue side and also on account of higher subsidy allocations, it is likely that market positioning would now focus on the possibility of RBI rate actions and also OMO’s at some point in this quarter. There is some headroom for accommodating additional borrowing requirement if they arise in the 4th quarter. 

The new mark-to-market valuation norms are applicable from 01st October. The average maturities in the liquid funds have been aligned accordingly. In line with our view on improving liquidity and gradual change in the RBI stance, we had been maintaining higher duration across our short term and longer term funds. 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 and also eventual compression in top rated credit spreads. 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.)