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October 2014

There  has  been  a  lot  to  cheer  in  India  -  the  ’Mangalyan’  in  Mars,  Gold  in  Hockey  at  the  Asian  games, Standard  and  Poor  (S&P)  improving  outlook  on  India’s  credit  rating  and  a  rousing  reception  to  the  Prime minister in the USA. The Chinese premier expressed deep interest in investing in India’s infrastructure while savoring Gujarati snacks with Prime Minister Modi on swings at the Sabarmati River Front. Another boon for India  has  come  in  the  form  of  falling  global  commodity  prices  as  a  result  of  a  slowdown  in  the  rest  of  the world,  particularly  China,  which  has  pursued  an  investment-led  growth  model  and  has  been  guzzling industrial commodities at break-neck speed.
Campaigns  like  ’Clean  India’  and  ’Make  in  India’  have  created  lot  of  buzz.  Whether  it  is  their  conviction  or compulsion,  we  believe,  this  government  is  unlikely  to  announce  any  ’big-bang  reforms’  but  would  stay firmly on the path of improving India’s ranking on parameters such as  ’ease of doing business’ and ’human
conditions  index’.  The  government’s  priorities  are  things  like  skill  development,  financial  inclusion,  e-governance,  infrastructure  improvement  while  legislative  reforms  like  overhauling  the  labor  laws  will  have to  wait.  Another  area  of  focus  would  be  on  reducing  the  friction  due  to  conflict  or  lack  of  co-operation  at
inter-departmental  levels  or  between  the  Centre  and  States.  The  financial  inclusion  plan  will  expedite  the direct  benefits  transfer  (DBT),  improve  tax  revenues  (as  a  greater  part  of  economy  comes  to  mainstream) and  will  help  in  promote  household  savings  and  channelizing  it  into  productive  assets.  The  clean  India campaign  will  not  only  help  improve  general  hygiene  and  female  literacy  (toilets  in  schools  lead  to  higher participation)  but  will  also  unleash  the  humongous  potential  in  tourism.  The  thought  process  behind  all these  is  that  India  needs  to  leverage  the  full  potential  of  its  demographic  dividend  by  improving  the  social infrastructure,  skilling  young  people  and  creating  jobs  that  would  lead  to  higher  disposable  income  and spending. Eyeing this opportunity, more  investments would come,  in turn leading to creation of more  jobs and incomes thus setting a virtuous cycle in motion.
There  are challenges.  The  judicial pronouncements on  the coal block  allocation would  surely pave  the  way for  a  fair  and  transparent way of  natural  resource  allocation  but  has created  some  uncertainty  in  the  near term. The world isn’t  in  great  shape  either; geo-political risks abound with  Middle-East  and Russia-Ukraine
still vulnerable. Tear gas on protestors in Hong Kong makes one nervous about the sign of things in this part of the world. Euro-zone, Japan, China and several other emerging economies are finding it tough to keep the growth  momentum  on.  Expected  normalization  of  US  monetary  policy  can  reduce  the  risk-appetite,  in general,  with  larger  impact  on  emerging  markets  like  us.  Any  negative  surprise  in  the  upcoming  State elections may impact  business  and investor sentiments. While we firmly believe  that  the worst of macro is behind us, the pace of recovery  needs to be  watched.  The  corporate balance  sheet  in India  seems to be  in good  shape  but  beneath  it  is  a  big  divergence  with  a  section  that  is  quite  strained.  Slowdown  in  credit growth also reflects that banks have finally shut the taps for those whose balance sheets are over-extended. We  also  have  to  reckon  the  possibility  of  large  supply  of  equity  issuances.  While  India  surely  looks  like  a favored investment destination in a growth constrained world but there is no reason to be complacent.

Given that equity valuations are marginally above the historic average, we expect the markets to consolidate at  current  levels.  Notwithstanding  the  near  term  challenges  and  expected  volatility,  India  looks  well positioned  to  deliver  a  sustainable  bull  run  in  the  long  run  on  the  back  of  stabilizing  macro,  reviving corporate  earnings  growth,  near-average  valuations,  and  better  liquidity  both  from  foreign  as  well  as
domestic investors.

The ’way of doing business’ is undergoing a shift with a new model of natural resource allocation, impact of technological changes and greater connectivity and a more agile, informed and demanding customer. There are  multiple  growth  drivers  at  play  such  as  revival  in  manufacturing  and  exports,  growth  in  consumption both at the higher end (premiumization) and at the bottom of the pyramid, penetration of technology with
higher  connectivity,  improvement  in  farm  productivity,  etc,  that  will open  up  new  frontiers  for  businesses. This is a new growth cycle for India and there would be another set of players that can gain scale in revenues and  profitability;  who  have  established  the  right  business  model  to  capitalize  on  upcoming  opportunities.
While keeping an eye on macro developments and identifying emerging themes and shifts, our greater focus remain on bottom up stock picking, we believe, is the best way to generate alpha on a sustainable basis.

With  the  RBI  adopting  the  inflation  glide  path  targeting  6%  CPI  inflation  by  January  2016,  the  monetary policy  stance  in  the  bi-Monthly  review  was  on  predictable  terms.  The  Central  bank  continues  to  remain cautious  about  the  medium  term  6%  target  even  while  acknowledging  that  upside  risks  to  inflation  have reduced over  the  last  few months.  The  access  to  refinance  under  Export  Credit  refinance  has  been  further reduced to 15%  of eligible export  credit. The  hold-to-maturity (HTM)  portion for banks  have  been reduced to 22% from 24% in a staggered manner till September 2015. The HTM ratio has now been aligned with the
actual SLR ratio that has been cut earlier.  

Average overnight rates eased during the month as government spending eased the liquidity shortage that has persisted since July. 

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.  
Strong  FII  demand  with  over  USD  20  billion  of  flows,  till  date,  subdued  credit  off  take  and  declining commodity prices have supported a softening trend in bond yields recently. This has also been supported by the  government  maintaining  its  commitment  to  fiscal  consolidation  and  also  announcing  reduction  in auctions and doing buybacks of securities. The RBI is likely to remain on a prolonged pause for the near term with the policy stance likely to be shaped by forward looking estimates on the trends of CPI inflation. Near term  market  trends  could  be  increasingly  dependent  on  trends  in  global  rates  and  flows  as  well  as  the evolution of inflation direction.  

We  have  been  running  moderate  duration  in  long  term  funds  with  a  positive  medium  term  view.  While yields look attractive from a historical perspective and relative to other countries, it may be a while before RBI considers monetary easing in the backdrop of the new monetary policy framework.

Navneet Munot

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