Market Update
Macro Economic Review
India’s macro-economic fundamentals continue to hold steady with lead indicators displaying healthy trends. Meanwhile, the RBI has projected India’s GDP growth to strengthen from 6.6% in FY ’18 to 7.4% in FY ’19 based on early signs of revival in the investment activity (as reflected in the sustained expansion in capital goods production) and an improving global demand that will encourage exports and boost fresh investments.
These projections are attuned with the Index of Industrial Production (IIP) data for the month of Jan ’18 (released in March ’18), which stood strong at 7.5%, higher than the consensus estimate of 6.4%. The growth was mainly led by capital goods where the activity rose by 14.6% and consumer non-durables that rose by 10.5%. Also, the eight core sector industries, that account for ~41% weightage in the IIP, grew by 5.3% in February ’18, aided by strong performance in the refinery products, fertilizers and cement segment, which also points to a healthy IIP growth for the month for February ’18 as well.
The ongoing trend of easing inflation is led by moderation in vegetable prices and suggests 4QFY18 inflation to sustain below the RBI’s initial forecast of 5.1%; which in fact has now been revised down to 4.5% by the RBI in its latest monetary policy review. Further, the predictions of normal monsoon rain this year, by Skymet (the private weather forecasting agency), also abates concerns pertaining to inflation next year and presents RBI some room to support the ongoing economic recovery.
The Monetary Policy Committee (MPC’s) status quo on rates in its latest review is thus hardly a surprise. In fact, the RBI has now revised its FY ’19 CPI projection to range between 4.7% - 5.1% in H1FY ’19 and to 4.4% in H2FY ’19 (including the HRA impact). The central bank has assumed Indian crude basket at US$68/bbl for FY2019 and sees 80 bps upside risk to inflation in case of deficient monsoons and MSP hikes.
In the ongoing scheme of things, the twin deficits continue to remain a sore point to an otherwise vibrant economy. While the February ’18 trade deficit narrowed to a more normalized level of $12bn after spiraling to $16.3bn in January ‘18 (a 5-year high), the same can be attribute to decline in imports rather than a pickup in exports. The export growth, in fact, dropped to 4.5% from 9.1% in Jan 2018.
India’s current account deficit (CAD) expanded to 2% of GDP (US$ 13.5bn) in Q3FY18 from 1.4% of GDP (US$ 8.0bn) in Q3FY17. We expect the CAD to remain around similar levels in FY19. Besides, the initial FY ‘18 fiscal deficit target also anticipates a slippage of 30 bps (3.5% FY18RE) - first time in six years. For the year, ahead, the focus will be on revenue collections amidst anticipated higher government spending (FY ’19 being a pre-election year) to contain the deficit closer to the budget estimate of 3.3% of GDP. On the revenue front, FY ’18 direct tax collections at Rs 9.95 trillion have exceeded the revised budgetary target of Rs 9.8tn, which is a big positive. However, on the indirect tax front, a sharp pickup in (GST) revenues, right from the beginning of FY ‘19 is needed to achieve the budget targets, given the monthly GST run-rate of Rs 917 billion in FY ’18.
Equity Market
Inundated with concerns on both global and domestic fronts, the ongoing correction in the Indian equity market deepened further in the month of March ’18, robbing the frontline indices more than 3.5% points during the month. While on the global front, the international trade war is gradually escalating, back home, political ambiguity is on rise following setbacks to the ruling party in the recently concluded by-polls. Besides, ruling party’s recent loss of a key ally, ahead of the general elections early next year, has added to the obscurity at the political stage. Moreover, sequential unearthing of wrong-doings in some of the country’s leading banks has added on to the market anxieties.
The lingering fear of tariff war between the US and China kept the Metals sector on the edge, which eventually, turned out to be biggest underperformer this month. The IT and the FMCG sectors however extended their outperformance through the month. Also, in a surprising turn of events, the Government’s proposal to moderate its borrowing program in FY ’19 helped smoothen some nerves and calm sentiments in the financial sector.
Foreign Institutional Investors (FIIs) returned as net buyers in Indian equities in March ‘18 with $1.9bn of equity inflows during the month, that took their Year to Date (YTD) inflows in Indian equities to ~$2.0bn. Domestic Institutional Investors (DIIs) meanwhile pumped in a net of ~$1.0bn during the month. YTD, DIIs have now bought $3.85bn worth of equities.
Over the next 2 months, the 4th quarter earnings’ seasons will likely keep the markets on toes. However, considering the ongoing recovery in earnings, as seen in the past quarter, earnings this quarter too can be expected to be on a strong footing.
Meanwhile, as highlighted last month, micro-fundamentals continue to improve with key lead indicators such as cement production, auto sales, production of capital goods, Govt. capex etc. showing healthy growth in recent months as compared to a year ago period. This strengthens confidence to the much-awaited recovery to the corporate earnings’ cycle in FY19.
We maintain our belief that the market will continue to recalibrate the recent gains in economic and earnings’ growth momentum against the emergent risks of inflation and higher interest rates for some time. The recent market volatility and correction of 7-8% from its highs in Jan 2018 are in line with this view. Our portfolio approach continues to remain balanced with bottom-up stock selection and sector selection playing an equal role. We believe evidence is emerging on the strengthening of pro-cyclical stance and accordingly some shuffling in our portfolios is currently underway to capture a potential industrial/manufacturing recovery. Cyclicals with comfortable balance sheets and attractive valuations and companies with strong franchise value but presently facing growth headwinds are drawing our attention.
Fixed Income Market
The surprisingly sharp decline in the consumer price index (CPI) inflation in the month of February 2018 has triggered a sweeping change, for better, in the ‘fixed income’ market sentiments, which have otherwise been feeble for a while now.
From a high of 5.21% in Dec ’17, the CPI moderated to 5.07% in January ’18 and further to 4.44% in February ’18, largely led by a decline in vegetable prices. With inflation moderating, speculations for a possible rate hike in the immediate future have also been put to rest for the time-being. As for the near-term, i.e. the policy review in June ’18, the rate hike decision would be mainly influenced by the onset and the progress of the monsoon. All the same, the CPI inflation post June ’18 is expected to continue to tread lower, given the low base effect, and is likely to stay at under 4% until Dec ’18.
In yet another surprisingly pleasant move, the government of India lowered the amount of its gross borrowing from the market for FY ’19 by ~Rs 50,000 crore. Against its original targeted FY ’19 gross market borrowing program of Rs 6.05 lakh crore; the government now intends to fund ~Rs 50,000 crore partly from National Small Savings Fund (NSSF) and partly through lower buyback. Besides, in a shift of sorts from its tradition of frontloading its borrowing program in the first half of the year, the government this year has decided to borrow under 50% of its FY ’19 targeted annual borrowing in the first half of the year as against its conventional practice to borrow ~65% in that period. Additionally, the government has also decided to lower the issuances in the medium-term segment of 10-14 years to around 29% vs. 50% issuances in the previous years. These announcements resulted in a surged demand for the long bonds and the yield of the 10-year benchmark dropped sharply by ~30bps in an immediate consequence.
Come to think of it, such sharp yield movements are not common in the context of Indian fixed income market and re-collectable instances of such swift yield movements are just about 7 trading days in past 10 years. So far, the 10-year benchmark yield has dropped by about 40bps lower from its high of 7.80% seen in early March ‘18.
In fact, by lowering its borrowing program, the government has also suitably addressed the mismatch in the demand and supply of G-Secs (gilts).
Now, going forward, the market is awaiting an announcement from the RBI regarding enhancement of investment limits for foreign investors in the domestic market; the occurrence of which will also be positive for the gilts and bonds.
Through the year 2017, the sell-off in the bond market was largely led by jitteriness and fears of potential rate hikes. These fears have somewhat been allayed for the time being, and are unlikely to create furor until June ’18 when monsoons could guide the RBI’s course on interest rates. Also, since the RBI has not already hiked the repo rate despite highlighting the risks to inflation in its last policy, we do not expect a rate hike from RBI unless the headline CPI goes beyond the forecast 5.60% in the first 6 months of FY19.
In the given market conditions, we urge investors to be cautious and pick fund duration aligned to their investment horizons. We do not expect any rate reductions soon but we do hold on to our stance for a need for tighter real rates and endorse efficient allocation of capital and savings/ investment. Currently we are at an interesting juncture where there is also a probability of RBI turning less hawkish in the coming months. In fact, in the event of some softening in repo rates (as RBI acknowledges lower CPI in the second half of the calendar year and feels the need to contract the real rates), there will be newer opportunities for investors on long duration and investors may then initiate some strategic investments. The market, in due course, is expected to move in sync with the Monetary Policy Committee (MPC’s) rate decision, which is expected to take cognizance of developing inflation and growth dynamics.
Last Updated: 15th April 2018
Next Update On: 15th May 2018
Update Frequency: Once Every Month
