Market Update
Macro Economic Review
Indian macro-economic parameters are showing mixed trends, albeit better than those seen in past three years. While economic activity indicators like cement consumption, commercial vehicle sales and Index of Industrial Production (IIP) numbers are showing a positive trend, the inflationary environment (though within the RBI’s comfort zone) and the rising trade deficit is a cause of concern.
The surge in the IIP for the month of November ‘17 to 8.4% vs 2.2% in October ’17 was largely led by the manufacturing sector. The spike could well be attributed to the festival related distortions and corrections therein cannot be ruled out, based on instances in the past. Capital goods output too improved to 9.4% vs 6.6% in October ‘17 while electricity production inched up to 3.9% vs 3.2% and mining rose marginally to 1.1% in Nov 2017.
Consumer Price Index (CPI) inflation rose to 5.2% in December ’17 vs 4.9% in November ’17, with Core CPI inflation rising to 4.5% year on year (yoy), having ranged between 3.9% - 4.1% in past 6 months, led by health and education services. The Wholesale Price Index (WPI) inflation, on the other hand, eased to 3.58% in December ‘17 vs 3.93% in November ’17, primarily due to fall in the prices of fruits and vegetables.
The RBI, in its latest bi-monthly monetary policy review, while maintaining a status quo on interest rates, has now projected CPI inflation to range between 5.1% - 5.6% in the first half of FY ’19, while estimating it to moderate to 4.5% - 4.6% in the second half.
Trade deficit for the month of December ‘17 rose to a 3-year high to $14.88bn vs $13.8bn in the previous month, primarily led by hardening in commodity prices including crude oil and gold. Gold imports, in fact, zoomed by 71% in December ’17, having posted a decline for 3 straight months previously while the oil imports were up 35%. Exports too rose by 12.36% led by engineering goods even as exports of gems & jewelry were muted.
Meanwhile, in a key development, the government, in the Union Budget for FY ’19, raised its fiscal deficit projections by 30 bps each to 3.5% of GDP for FY ’18 and 3.3% in FY ’19, thereby altering the glide path to fiscal consolidation. We, however, believe, that the overall impact of fiscal slippage on macro-economic stability will be manageable.
To summarize a few highlights of the budget, the government has projected receipts growth of 12% and an expenditure growth of 10% for FY ‘19. Tax receipts are projected to grow at 17% and revenue and capital expenditure at 10% each. Expenditure growth has largely been focused on railways, roads and highways, agriculture and farmers’ welfare, and food subsidy (possibly factoring in higher MSPs or higher procurement). The net market borrowing (dated securities without adjusting for buybacks) has been budgeted at Rs. 4.6 trillion and gross borrowings at Rs 6.05 trillion implying a significant proportion of financing coming from non-central government bond funding, as well as cash balance drawdowns.
Equity Market
The Indian equity markets continued to strengthen in the new year, with the benchmark Nifty index gaining another 5.7% in January 2018 over the previous month, largely reflecting the strength in global equity markets. However, unlike the previous many months, the broader market was weak, with the Midcap index underperforming the large cap index by over 7.2% during the month. The market has been supported by upbeat institutional inflows with FIIs returning as net buyers for the fourth consecutive month, and the Domestic Institutional Investors (DIIs) emerging as net buyers for 10th straight month led by Domestic Mutual Funds.
Overall gains, however, have masked some of the imminent near-term risks, including residual impact of GST and demonetisation, hardening commodity prices including oil and a weakening debt market due to the sharp rise in benchmark yields, all of which, at the margin, can prove discomforting for equities. The concerns were further accentuated with the government shifting fiscal deficit targets by about 30 bps for both FY18 and FY19.
The Finance Minister (FM) has presented a manageable Budget for 2018-19 - targeting a fiscal deficit of 3.5% and 3.3% for FY 18 and FY 19 respectively. Minimum Support Price (MSP) for agricultural crops have been pegged at 1.5x (times) the production costs. Though positive for rural economy, revision in MSPs could have an adverse impact on inflation. The Government also presented the National Health Protection Scheme which can help boost healthcare infrastructure in the country while providing health protection to population in the low-economic strata. Meanwhile, re-introduction of long term capital gains (LTCG) for equity securities is being reckoned as a negative move for the equity markets, even though the government has attempted to dilute its impact by enabling a grandfathering clause for the past gains till January 31, 2018.
Having said that, we believe, that the government’s reform agenda strengthens our base case for a back-ended recovery in the earnings for 2HFY18 and will, likely, enable investors position themselves for a full-blown earnings growth in FY19 and beyond.
In the current environment, while our portfolio approach continues to remain balanced, reflecting the bottom-up conviction on specific companies rather than mere sector considerations, we believe that there is now an increasing evidence to strengthen our pro-cyclical stance. Meanwhile, our portfolios have seen some desirable shifts to capture the opportunities for a potential industrial recovery. We do back cyclical companies but only where valuations are reasonable. On a bottom up basis, we are willing to invest in companies across sectors that are experiencing near-term headwinds, provided the valuations are attractive. However, we remain wary of balance sheet risks. Our approach has been incrementally more constructive towards large cap equities vis-à-vis the smaller companies and that is unchanged based on current valuation differentials.
Fixed Income Market
The bond market has been adversely affected due to lower than anticipated growth in the tax revenue vis-à-vis the budgeted estimates. This gap between the actual and the target revenue is being met through additional borrowings, which is expected to result in potential slippage in the fiscal deficit target for the FY18. The uncertainty in the attainment of the fiscal target, has somewhat weakened the market sentiments and the bond yields have moved higher in the wake of lower demand from the domestic investors.
The double whammy of headline CPI inflation overshooting the RBI’s target range, leading to uncertainty over RBI’s future course of action as well as the pronounced slippage in the fiscal deficit target for 2017-18 fiscal has amplified the nervousness in the bond market, which continued to witness sell-off through the month. The yields are almost 150 bps higher as compared to last year.
At 5.21%, the headline CPI for the month of December ’17 overshot the RBI’s revised inflation target range of 4.3% - 4.7%. The rise in inflation can be attributed to high food prices, impact of hike in the House Rent Allowance (HRA) to the central government employees and the transitional effect of Goods & Services Tax (GST) on the services sector. The absolute impact of HRA and GST is likely to be felt until June 2018 and has the potential to push inflation further up to 5.80% - 6.00% band. While the food price inflation is transient, the new method of calculating Minimum Support Price (MSP) may trigger secondary inflationary tendencies, which may give rise to wage inflation in the rural economy that can spill over as generalized inflation.
The government, as feared, raised the FY ’18 fiscal deficit target to 3.5% of GDP from its earlier projection of 3.2% of GDP, which is being perceived in a poor light by the market as the government, in past 3 years, could meet the fiscal targets. In fact, the current year’s fiscal slippage is being viewed more severely, particularly in the wake of general elections being scheduled in the year 2019.
The 10-year benchmark (the old issuance) yield has moved from 7.39% to 7.85% last month in wake of the.
- Fiscal slippage
- Relaxed fiscal target for FY19
- Negative market sentiment
- Higher CPI
- Steadily firming up of oil prices
- Sell-off in the US markets
- Assumed high risk of holding excessive G-Secs by the PSU Banks, as highlighted by RBI deputy governor Viral Acharya
- The new cost plus formula (1.5x of cost) of calculating the Minimum Support Price (MSP) for agriculture commodities
Having said that, a steady rupee along with rising forex reserves over past 2-3 years is a big positive for the market. Foreign portfolio investments (FPI) inflows in both debt and equity markets as well as steady inflows on the Foreign Direct Investment (FDI) front have lent the desirable stability to both forex reserves and the rupee.
Going forward, with bond yields moving north due to weak market sentiments, higher fiscal and high market borrowing, we do not expect the real rates to contract unless led by some policy action from the RBI or the government. The present concerns pertaining to high inflation support RBI maintaining its hawkish stance on inflation. We feel the market has started pricing in the few rate hikes, given that the 10-year benchmark is trading at a spread of 160 bps over the repo rate.
In the given market conditions, we urge investors to be cautious and choose fund duration in line with their investment horizons. We do not expect rate reductions any time soon in the wake of fiscal slippage but hold on to the argument for a need to have tighter real rates and push for more efficient allocation of capital and savings/investment. The market, in due course, is expected to move in alignment with the Monetary Policy Committee (MPC’s) rate decision, which is expected to take cognizance of developing inflation and growth dynamics.
Last Updated: 15th February 2018
Next Update On: 15th March 2018
Update Frequency: Once Every Month
