Market Update
Macro Economic Review
In the latest print, the Industrial Production (IIP) data rose to 4.9% with a sharp rebound in capital goods and steady growth in infrastructure and construction sector. Mining and manufacturing expanded by 5.1% and 5.2% respectively while electricity production fell to 2.1% The growth was broad based with 16 out of 23 industry groups in the manufacturing sector registering growth.
Meanwhile, the government recently approved the much-anticipated hike in the Minimum Support Prices (MSP) for Kharif crops. The price rise ranges from 4% - 53% for variety of crops, resulting in an average price hike of 24% which is the highest increase since 2012-13. Having said that, the MSP hike was statistically well managed due to contained hike of about 13% in price of paddy, which enjoys a reasonably high weight in the food basket. Nearly 10% of the total CPI basket will be impacted by the MSP hikes, but with the current market prices being close to the new MSP prices for some crops, the inflationary impact of the MSP hike is likely to be restricted in the range of 50-60 bps.
The RBI, in its upcoming monetary reviews is thus expected to take cognizance of the sticky core inflation and the rising upward risk to the overall Consumer Price Inflation (CPI). So far, the CPI has continued its upward trajectory with a print of 4.87% from 4.58% in the previous month. The rise was on the back of core inflation which increased to 6.2%YoY and fuel inflation which rose to 5.8%YoY. Also, the Wholesale Price Inflation (WPI) at 4.43% YoY was driven by higher petrol, diesel and vegetable prices.
In the meantime, the GST collections continue to be robust, though marginally short of the required rate. The GST collection in the first two months of FY ‘19 averaged Rs 987 billion, a tad lower than the monthly target of Rs. 1.06 trillion for FY19.
The trade deficit in the month of May ‘18 widened to $14.7 bn versus $13.7 bn in April ‘18, despite a 20% growth in exports as imports were driven up by a strong 13% growth in non-oil and non-gold imports. On a 12-month rolling basis, the trade deficit at USD 158 bn is the highest in last five years which is a cause of worry as it will put pressure not only on the Current Account Deficit (CAD) but also on the already weakening currency.
Monsoon continues to remain in the advancing stage with data till June’18 end reflecting a cumulative deficit of only 4% to the long period average. The total sown area as on 29th June 2018, stands at 165.2 lakh hectare vs 210.7 lakh hectare YoY. With higher MSP to farmers and IMD expecting a good monsoon - 101% rainfall forecast in the month of July, we expect better sowing trends going ahead.
Despite a high commodity price scenario and its impact on inflation and GDP posing threat, the headline growth numbers continue to hold steady. In fact, a good monsoon and buoyancy in rural economy aided by MSP increase could keep the economy running at a stable pace going ahead. Also, with rise in the commodity prices steadily waning, any moderation in the commodity prices could positively catalyze the already steady economic growth.
Equity Market
Mirroring its previous month’s performance, the Nifty once again, in June ’18, ended the month on a flat note. Those who kept the market on its toes this month include – the RBI, who raised the repo rates by a quarter basis points, its first in 4 years, and Fed, who is incrementally turning hawkish. Besides, Organisation of Petroleum Exporting Countries (OPEC) and its allies consented to a rise in the oil production by 1 mbpd (million barrels per day). The oil prices, nevertheless, continued to remain firm. Meanwhile, back home, the Goods & Services Tax (GST) collections continue to be robust despite falling marginally short of the target. Further, in an interesting turn of events, the government has approved a substantial increase in the minimum support price (MSP) of most Kharif crops, which is likely to cost the exchequer more than Rs 15,000 crore.
As far as the investor flows are concerned, Foreign Institutional Investors (FIIs) continued with their selling spree while domestic mutual funds and insurers continued to pour money in equities. The varied equity market performance this month saw Pharma sector outperform (+14%), led by sector rotation, rupee depreciation and series of good news flow for the sector i.e. regulatory & plant clearances for domestic pharma companies by the U.S. A depreciating rupee also supported the export driven Information Technology (IT) sector, which outperformed by 4%. On the other hand, Industrials (-8%), Utilities (-6%), Metals and Mining (-5%), were the top underperforming sectors in June. Also, Midcaps (-4% in June) continued to underperform the Nifty (+0.7%).
Meanwhile, Monsoon continued its advancing stage with the India Meteorological Department (IMD) forecasting a good monsoon in the sowing month of July with a 101% rainfall, a and 97% forecast for the overall June-September monsoon period. While core sector trends in areas like infrastructure and private sector capex are still weak, consumption trends, as reflected by auto sales, consumer credit growth etc. are reasonably strong and can further strengthen following a good monsoon season.
While Indian markets will likely reel in the influence of global factors like trade conflicts and commodity prices, the upcoming result season, in our view, will be a key determinant of near-term market trends given the widespread expectation of earnings recovery in FY19. We continue to maintain that the market will likely remain in the mode of re-calibrating recent gains in economic and earnings growth momentum against emergent risks of inflation and higher interest rates for some time and this will likely keep markets volatile for some time. The recent sharp fall in mid and small cap stocks, as anticipated by us for a while now, has added to the overall market volatility. But all the same, it has also expanded investment opportunities in the wake of steep corrections in valuations.
In the given backdrop, our portfolio approach continues to remain balanced with bottom-up stock selection and sector selection playing equal roles. We maintain that there is an emerging evidence on a strengthening pro-cyclical stance and accordingly, some portfolio shifts to capture a potential industrial/manufacturing recovery are underway. Cyclicals with comfortable balance sheets and attractive valuations or companies with strong franchise value but presently facing growth headwinds do attract our attention.
Fixed Income Market
The 10-year yield in the month of June ranged between 7.76% and 8.01%, ending the month at 7.90%. This month the Monetary Policy Committee (MPC) unanimously decided to increase repo rate by 25 basis points while maintaining the stance neutral. The reasons cited were increasing oil prices, elevated core inflation, household surveys indicating higher inflationary expectations in the 3-month and 12-month period, closing output gap and robust growth. In our view the RBI went in for the rate hike as, despite benign food prices, headline inflation has been printing above 4% target, consistently elevated core inflation (ex food and ex fuel inflation) and because of the narrowing output gap. Thus, the MPC hiked rates to quell the rising inflationary expectation.
Headline Inflation for the month of May ‘18 came in at 4.87% and was as per expectations. Continued selling by the Foreign Institutional Investors (FIIs) in the equity and debt markets, hardening oil prices, weakening trade account and dollar strength led to weakness in the domestic currency (INR). The volatility in the INR led to RBI intervening in the foreign exchange market. There has been close to 17 billion USD drop in foreign exchange reserves following RBI’s intervention from 31st Mar 2018 till end of June 2018. This has resulted in liquidity being squeezed out. In keeping its commitment to maintain durable liquidity, the RBI announced Open Market Operations (OMO) of 10,000 crore INR in June ‘18.
Unlike the previous MPC minutes, the tone of the latest minutes was akin to the policy statement itself. The release of minutes, opportunely timed with moderating Brent oil price that fell to level below 75 USD per barrel and the OMO announcement together brought cheer to the market and the yields declined to a low of 7.76%. However, thereafter, profit booking and with oil price trending higher once again caused the 10-year Government of India GOI security (G-sec) to close at 7.90% towards the month end.
We are one month into the monsoon and so far, the distribution has been spatial (certain states in Eastern India have received 20% below normal monsoon), which is not very encouraging. Besides, the overall rainfall across the country has been recorded to be about 8% below normal as of July 6th. Also, the sowing of kharif crops has been 14% below normal. However, the government still believes that the acreage will increase and food output would exceed last year’s output of 279.5 million ton. A normal monsoon is required to keep a lid on inflationary expectations.
The much-awaited Minimum Support Price (MSP) for the kharif crop was announced in early July by the Government. Paddy MSP has registered a 12.9% increase while other items increased range from 3.7-52.5% On a weighted average basis (weights as per the CPI basket) overall MSP’s were hiked by 14.8% yoy in FY19 versus 6.1% in FY18. Higher MSP’s will add to both inflation and fiscal burdens. To make MSP effective the government needs to expand its procurement operation. An ineffective i.e. on current procurement policy is estimated to push headline inflation by around 30 bps and fiscal impact would be 0.05% of GDP. Nevertheless, it is very unlikely that the procurement would be effective in FY19 in the absence of required infrastructure.
In the upcoming monetary policy review, due in August ’18, the MPC’s view on MSP hikes and its effect on inflation and fiscal, progress of monsoons and the oil price trajectory would weigh on the policy action. We believe as inflation prints are expected to be softer thereafter (July to December) the window for rate hike is virtually closed for this calendar year.
Despite the underlying inflation commentary, monsoon progress, elevated Oil prices, weakening trade numbers, INR weakness and continued selling by FII, the 10-year GOI yield at and around 7.90% -8% has seen strong domestic investors buying. Basically, steep yield curve pricing in multiple rate hikes, expectations of continued OMO’s by the RBI to infuse durable liquidity has probably capped the upside in yields around 8%.
While the steep yield curve offers opportunities for investors, the volatility in the market may continue, which makes sense for investors to weigh their investment horizons and then take investment calls. The risks to this view is weakening fiscal numbers and quickening domestic inflation.
Last Updated: 15th July 2018
Next Update On: 15th August 2018
Update Frequency: Once Every Month
