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September 2012

Despite the growth concerns, Indian markets outperformed most other markets on account of hopes of reforms and monetary easing. The markets ended up higher 1.1% MoM. Year-to-date, India is the 9th best performing emerging market and second best in Asia. 

News flow from developed economies was mixed. While the economic data from US was relatively stable, data releases from EU and Japan were weaker than expected. In the Jackson Hole statement, the Fed chairman defended the use of non-conventional tools to keep monetary policy extra-supportive for growth. Policy environment in the European Union remains fluid. 

On shore, the policy paradox continued. The government prodded with incremental positive baby steps towards GAAR recommendations (proposal to delay the implementation by 3 years) and the much awaited clarity on the spectrum auctions (pricing, process and timelines). The positives were negated with the “coal-gate” and the resultant standoff that has stalled the parliament proceedings. Increased decibel of opposition along with resurgence of anti-corruption rhetoric has prompted whispers of probable mid-term elections. 

Key monthly economic indicators of growth and inflation were disappointing. GDP growth remained sub-6% for one more quarter. The street has now adjusted to a new growth normal of ~6%. IIP growth for July at 2.6% was below expectations. Separately, WPI inflation eased to 6.9% yoy in July, aided by a sharp drop in fuel price inflation. But core inflation increased from 4.8% to 5.4%. 

RBI continues to strive for fine balance by increasing the liquidity for productive sectors, without stroking the inflation expectations. The central bank is waiting for a discernible easing of inflation along with some reformative moves by the government, before it can proceed with any further rates cuts. 

On the positive note, the revival of monsoon, particularly in north India, has raised hopes of a better-than-expected kharif crop production. The overall monsoon deficit now stands at 12%, better than 19% at the start of the month. 

Market activity remained lackluster during the month with cash and derivative volumes weakening further. The FIIs flows were positive almost each trading day through August (net inflow of USD1.5bn) as Domestic mutual funds on the other hand were net sellers with outflows of USD 330 million. 

Recently concluded earnings season witnessed consensus earnings estimates for the broad market revised down by ~120 bps. The street now estimates earnings growth of 12% and 13% for FY13E and FY14E respectively. The breadth of earnings revisions was also negative. Going forward progress of monsoon and the return of consumer in festive season remain critical for the direction of the market. 

The Indian growth machine is certainly taking a break, where it is in a self-correcting overhaul and is molting its excesses. Corporates are certainly witnessing pressure on margins and higher financial costs. The extension of current economic environment would put India Inc. to test, both in terms of ability to sweat the assets and re-engineer its business finance. While it is struggling in absolute as a limping runner, India is well placed in a race where others have lost direction. The new normal of a ~6% GDP growth – is lower than its recent show – but is among the top quintile among the relevant peer sets. Markets are slave of performance, demand-supply and behavioral excesses. As of now, liquidity is a prime factor that is contributing the market direction. 

A period of overhaul (economic/ social/ financial) does have its pain. We feel this period of consolidation will test the patience and commitment of believers of the India story. We remain confident that the outcome would be better and more durable. The sustained global flip flop on the Risk-On/ Risk-Off (the main driver of liquidity and sentiments) would contribute its own in terms of volatility – providing enough opportunities to seize the value on offer in the market. 

We firmly believe that such an environment should reward investors who remain alert to the concept of value, and disciplined in their established rule-set.  We remain resolute in our core belief strategy of investing in quality (business franchise, earnings, cashflow and management). We also stay strategically alert and tactically agile to capture each opportunity that a volatile market provides on valuation and trading.

In the absence of any near term expectations on the policy rate front post the RBI review in July, the market direction has been influenced by the demand – supply scenario and incremental data releases. The benchmark 10-year government security yield traded in a range of 8.24% to 8.14% during the month and closed flat at 8.24% on a m-o-m basis. Recent macro data points have continued to reflect broad based weakness in growth numbers. RBI’s preferred measure of core inflation i.e. the non food manufacturing inflation, however moved higher to 5.4% y-o-y as against the range of about 5% over the previous few months. Elevated international crude prices and the absence of fiscal consolidation measures especially on the subsidy front continue to act as a near term negative on the rates front. The net supply of government securities in the primary auctions during the month of August at Rs 750 Billion was the highest in the fiscal year so far. The net supply of Government securities in the month of September at Rs. 360 billion is lower than the previous month, which could support yields in the coming months. It is also likely that the RBI might look at undertaking OMO’s in the coming months to address the seasonal liquidity pressures on account of tax outflows and festive season currency withdrawals from the banking system. 

The RBI commitment to pro actively address the liquidity constraints is likely to support bond yields, even as the fiscal side constrains aggressive monetary actions in the near term. In the context of the RBI’s constraints on reducing policy rates to address the growth slowdown, given the fiscal concerns, we continue to anticipate incremental measures to ensure that liquidity remains comfortable and banks are able to gradually ease lending rates. Any incremental fiscal measures to address the supply side issues would be positive for rates. 

The money market rates have moved down over the month on improving liquidity and lesser issuances of CDs. This trend is likely to persist for a while and would lead to a more steep money market curve. Inspite of the near term uncertainty on the reduction in policy rates, domestic growth moderation combined with the weak global growth backdrop would provide space for policy rates to move down lower gradually. SBI Magnum Income Fund and SBI Dynamic Bond Fund are suitable for investors with risk appetite and horizon of at least a year. Short term bond spreads remain attractive and given the prospects of improvement in liquidity, we could see further easing in yields and also eventual compression in top rated credit spreads. SBI Short Horizon - Short Term Income Fund is rightly positioned to benefit from the same and would be suitable 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.)