NIFTY rose 8% in March and Rupee gained 2.3% against the US dollar. This helped Indian markets to catch-up with year-to-date under-performance relative to the emerging markets (Year-to-date, MSCI-EM is up 9.6%, MSCI India 6.6%, NIFTY 7.6% in US$ terms).
FIIs have invested over US$ 10 billion between 25th Feb to 3rdh April 2019 (US$ 8.5 billion in equity and US$ 2 billion in debt). The recent foreign inflows are more a reflection of India catching up with the other emerging markets. The global narratives around emerging markets had begun to change favorably since the start of the year, helped by increased dovish bias by the US Fed and easing trade tensions between US and China.
While the market sentiments have improved, economic activity has moderated and may remain so in 1H 2019. In recent months, the negativity around India’s growth outlook has stepped-up. It stems from a) signs of slowdown in global growth, b) strains in government’s finance and the rising clamor around social and income support measures which inhibits government’s ability to continue with the infrastructure support, c) evidences of weaker sale in various consumption items (such as auto sales, domestic air travels, textiles and other discretionary), d) weakening non-oil non gold imports which is closely linked to domestic industrial/ investment activity and e) challenges in the NBFCs which has affected the fund availability in the wholesale loans and real estate segment.
The concerns around government’s growth supporting capability are rightly placed. We may turn a bit prescriptive to say that while the income distributional policies are good to realize the demographic potential, the government of the future cannot lose focus on growth and productivity enhancing measures. Here, a better tax compliance and subsidy rationalization can help significantly to change the fiscal
arithmetic.
We had been growing increasingly vary of the impediments to India’s consumption growth momentum. Over the last several years, consumers were dissaving and consuming more than their income growth, helped by increasing access to the leverage. Such a growth has its own limits. And consequently, the consumer sentiments had weakened over time as the farm sector witnessed depressed income, unorganized sector struggled with GST and employment prospects remained weak. Moderation in auto sales and air traffic are on anticipated lines but one also needs to keep in mind the former could be normalizing after the above average growth in last three years and the latter could be suffering from supply side shocks. Hence, a strong base to support further consumption growth is amiss.
While the near-term outlook on consumption growth is hazy, the structural story hasn’t changed. The low penetration, rising aspirations of the youth coupled with recent taste of the EMIs and government’s support via various social sector schemes should keep the consumption demand afloat over a longer period.
While India’s growth may remain below potential in the near term, some pick-up is likely by the year-end. We expect investment activities to pick up. The easing domestic financial conditions should also help as the effects transmits into the real economy. Mainstream banks have stepped up to offset some of the growth drag from the NBFCs. The reforms, regulation and time correction in real estate prices over last five years have now created a favorable base for some pick-up in demand.
Strong foreign flows have led to a decent rally in indices; we expect market to consolidate these gains in the near term. Apart from noise around elections, market will take cues from the global market developments and earnings season. We have been calling for an earnings recovery and estimate growth of about 13% in FY19 and +20% in FY20 for the NIFTY. After the steep correction over the last one year, there is valuation comfort in the small and mid-caps. Over the last several years, market favored growth, rather consistency and predictability of growth and was willing to pay any premium for handful stocks exhibiting such trend. As broad-based profit growth was scarce, ‘Growth/Quality at Any Price’ has worked very well for a long time now. With a positive change at margin and profit growth likely to become more dispersed, the trend is undergoing a change. We are seeing a comeback for Value as an investing style and expect the trend to continue.
Coming to the bond market, March has witnessed a rally in the fixed income space (across G-sec, SDLs and corporate bonds). This partially exhausts our thesis of attractive valuations as a reason to go long in fixed income space. But fundamentals are still supportive.
Global narratives favor easing monetary policy. India's external finances have improved. Capital inflows have risen and are likely to push the balance of payments back into surplus (after three quarters of deficit). That said, weak export competitiveness keeps the country vulnerable to oil price moves or an uptick in domestic growth. Sudden reversals or a halt in capital flows are all too common.
The positive foreign capital inflow and the possibility of reduced currency leakage post-election should ease the banking system liquidity which has been in deficit for two quarters now. Inflation will likely remain contained in 2019. The central bank has cut the Repo rate by 50bps thus far. We expect another 25bp cut (either in June or August) and then pause as the RBI weighs the effect of the cumulative 75bps of policy easing.
One area remains challenging. A high fiscal deficit and elevated public sector borrowing by the central government, the state governments and public sector enterprises has created the demand-supply concern and impedes the transmission of policy rate cuts into the long-end of the government yield curve. The recent RBI action to adopt FX swap as a liquidity lowers the possibility of aggressive OMOs in FY20 thus adding to the demand concerns. That said, we believe that the strength of other fundamentals factors will create the demand from other channels and somewhat offset the reduced RBI demand. Hence to sum, we still see the possibility of more gains from staying long in the bond market.
A lot has been written to cheer the RBI’s FX swap auction. The central bank, in general, intervenes regularly in the FX market (either via spot or forwards/swap), but the intervention happens primarily to contain the rupee volatility and on some specific past instances, to shore up the dollar reserves by offering some form of cost subsidy.
The newness of this measure lies in the fact that it is for the first time an FX swap has been used as a tool for managing rupee liquidity. It is for the first time that FX swap has been done in the longer tenor (3 years), does not attach any subsidy, has been officially announced and conducted within a specified time frame (auction window).
Just like the RBI’s OMO operations alters the yield structure of the government bonds, the FX liquidity action also comes with some side effects, albeit a positive one in the current scenario. The announced intention to conduct a long-tenor buy-sell swap has helped to reduce the forward premium on Rupee, thus helping to reduce the hedging cost for importers and long-term financial investors in India. The 3-year cut-off premium came down to Rs. 7.76 on the day of the auction as opposed to Rs. 10 just two weeks ago. This in turn should help also to attract fresh foreign capital (both ECB and FIIs).
Further, in the current environment, most private banks had run down on their excess SLR and were not able to participate in the OMOs. The new tool has enabled the banks with foreign clientele and the liability base to participate in the RBI’s liquidity injection measures. By lowering the cost of foreign capital, it also helps the domestic corporates to raise dollar bonds, partly addresses the issue of crowding out effects of the government borrowings and may help to achieve some bit of monetary policy transmission. Hence, in the present scenario, the new scheme brings a multiple reason to cheer. However, only time will tell whether it carries any side effects which may not be blatantly visible as of now.
Navneet Munot
CIO – SBI Funds Management Private Limited
(Mutual funds investments are subject to market risks, read all scheme related documents carefully.)
