Macro Economic Review The broad economic conditions remained largely unchanged over the previous month. While the 3QFY14 GDP growth slowed down to 4.7% from 4.8% in 2Q, the quarter saw modest agriculture growth of 3.6%. Disappointingly, the growth within the industry contracted by 0.7% and services grew by mere 7.6%. The government also released the first GDP estimates for FY14, pegging growth at 4.9%. Factory output continued to contract as Dec IIP came in at -0.6%, taking Apr-Dec growth to -0.1. With the decline in the vegetable prices, the headline CPI continued to ease in Jan’14, coming in at a two year low of 8.8% from 9.9% in Dec’13. The drop in inflation was supported by an ease of fuel inflation. However, core CPI remained at unchanged levels of 8.1%. WPI followed a similar trend, as the Jan’14 print was at 5% vs 6.2% in the previous month. Core WPI rose up to 3% from 2.8% in Dec, though this is partly seasonal due to price revisions at beginning of calendar year. The IIP for Dec’13 contracted by -0.6% compared to -2.1% of Nov’13. The slow growth in the manufacturing sector is expected to have some disinflationary effect on the general level of prices within the economy. Based on the Urijit Patel recommendation of targeting the headline CPI inflation for all monetary policy actions (i.e. 8% CPI inflation by March 2015), RBI raised the repo rates in the last policy review in end Jan’14. The rate hike surprised the market participants as the market was expecting no change since there was a sharp decline in the headline inflation compared to the previous month. The purchases by FIIs in the debt segment continued to be positive for the 3rd month in a row with a purchase of $2.5 billion in Feb’14. While in the interim budget, PM announced a lower fiscal deficit of 4.6% for FY14 and estimated a 4.1% fiscal deficit for FY15, the market reactions seemed to be cautious about the achievement of the budgeted estimates. The net market borrowing of the govt in FY15 is also estimated to be lower than the previous year. The visible stress in the asset books of many PSU banks and the general slowdown across the economy is having its effect in business confidence. Equity Market After a weak start to the calendar year, the Nifty picked up in Feb (+3.1%). There was stock specific action on the back of 3Q earnings in early Feb but, overall the Indian market moved largely in tandem with regional markets. FIIs and DIIs both ended the month as net buyers, at $418mn & $44mn respectively. Valuations are in the comfort zone–they are not expensive but neither are they cheap: trading slightly below long term averages. On a forward basis they are at a slightly higher discount to average. However, given the macro environment we find current high teen earnings growth forecasts for the markets for FY15 to be suspect & hence we do not emphasize forward valuations. We see volatility increasing in the days ahead driven both by local & global issues. And this might have more to do with non-economic issues. The areas we have highligted as being attractive-in recent times-cheap cyclical stocks, Mid & Small cap companies & exporters have done well in recent times. We think these themes remain attractive but we continue to avoid companies with balance sheet risk. We are of the opinion that stock selection remains the key to generating alpha in this environment. Fixed Income Market Over the month of February’14 the yields of most assets hardened in the market. As the financial year end is drawing to a close the cost of money has gone up leading to hardening of yields of most securities. Higher quantum of issuances compared to the maturities of CDs pushed up the yields of bank CDs. The yields of 3m CD went up from 9.50% to 9.80%. The yields of 12m CD went up from 9.65% to 9.76%. The yields of corporate bonds were largely unchanged due to demand from foreign investors. The month of Feb’14 saw over Rs. 18,000 crore inflow into Indian debt and money market securities by foreign investors. The yield of 5 year corporate bonds remained unchanged around 9.72%. The 10 year benchmark G-sec yields went up from 8.78% to 8.86%. The yields hardened despite net positive foreign inflow due to net selling by domestic fund. The market presumably was preparing for further rate hikes by RBI. While chances of further rate hikes are remote, as the headline inflation moves downwards, but still remains outside the target 8% on headline CPI. Few comments by RBI governor also kept the market participants nervous about trajectory of monetary rates. The estimated fiscal deficit of 4.1% for FY15 and a net market borrowing below current year failed to cheer market participants as there was widespread disagreement about attaining the budget estimates. The decline in gold imports and non-essential imports has led to a steady improvement in the CAD. RBI actions around maintaining currency stability has helped improve the general market sentiment while IIP declines. The drop in the vegetable prices has helped in the decline of the headline inflation. RBI has also maintained the overnight rates around the repo rate through continuous term repo auctions and has helped maintain liquidity at reasonable levels. While the domestic economic momentum lacks visible signs of growth, the positives roll-in from improved macro variables on the external front. Continued Fed tapering has had limited impact on both the currency and the rates. The liquidity position within the banking system is expected to deteriorate further due to the seasonal outflows from the advance tax payments towards mid-March. The overnight cost of money might just about be maintained around the repo rate of 8% due to the success of term repo auctions. Through the term repo auctions, RBI has infused additional liquidity beyond the infusions through the overnight LAF. The infusions through the term repos auctions has helped maintain stability in the overnight market and contain the rates closer to the repo rates. The yields of debt securities will move in line with inflation and RBI’s rate actions. The superior liquidity management by RBI gives comfort that the liquidity conditions will be maintained well over the following months too. Hence, the yields of short maturity papers are expected to remain largely around similar levels, while higher yields are not ruled out in the month of March’14 as outflows on account of advance tax payments. The reserve money creation will take a beating as the government expenditure seems to be largely over for the financial year. The inflows from foreign investors are expected to continue over the month as the currency remains stable with an appreciating bias. This is having a positive impact on the value of the currency. So while several EM currencies are feeling the heat of Fed tapering the behavior of the rupee is comparatively stable. Higher supply of corporate bonds might lead to some widening of spreads for corporates as the spreads are lower than the averages and additional market borrowing appears remote as fiscal deficit is being contained at a lower level of 4.6% compared to the budgeted estimates of 4.8%. Improved currency stability, lower headline inflation might refrain RBI from any further rate hikes from the present levels. Taking cognizance of monetary policy guidance, we are positive on long maturity bonds and gilts, which may provide opportunity for capital appreciation over a period of time. The probability for the G-sec yield to come off from the present yields is high due to RBI’s pause on rate hikes and the absolute levels, which is trading around 130 bps higher than the previous 10 year average yield of the benchmark. We recommend all funds of over 3 years plus modified duration, actively managed bond funds, which are in sync with the rate cycle and long duration gilt funds to benefit from capital appreciation. In light of the improved India’s external balances position, a calibrated US Federal tapering programme is not expected to induce undue volatility in the rates market. The sovereign rating continues to be under the threat of a downgrade in case the general election results are fragmented. On a medium to long term basis, the risks remains of a weak government unable to pursue a lower fiscal deficit from the new FY.
Posted on: Sat, 22 Mar 2014 11:19:31 +0000
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