Market Update
Macro Economic Review
The Indian economy continues to maintain steady performance. The earlier headwinds of higher commodity and crude prices seem to have waned off and barring fiscal situation the economy seemed to be moving along a steady growth path.
The Consumer Price Index (CPI) print of 17-month low at 2.3% with broad-based decline across food (-1.7% vs -0.1% Oct), fuel (6.7% vs 8.1% Oct) and core inflation, which was sticky so far came down to 5.7% vs 6.2% in Oct 2018.
RBI governor Urjit Patel resigned marking a rare event in the institution’s history with the government announcing Shaktikanta Das as his successor, a day later. RBI also announced a slew of Open Market Operations (OMOs) for next 3 months, taking the Jan-Mar quarter OMO to Rs. 1.5 trillion.
October Index of Industrial Production (IIP) growth jumped to 8.1% as capital goods production increased 16.8% YoY. Power Sector and consumer durables expanded by 10.8% and 17.6% respectively.
The trade deficit for Nov 2018 narrowed to US$16.7bn led by a sharp fall in crude prices and fall in gold imports. Overall imports grew 4%. One major cause of concern is slowdown in exports. Export growth slumped to 0.8% in November from 17.86% in October 2018.
In the 25 years since 1992, when India began liberalizing its trade regime, India’s share of world goods exports has risen from 0.5% in 1992 to 1.7% in 2017, while Indian service sector’s share rose from 0.5% to 3.4% during this period. This looks paltry in comparison to China whose share of world merchandise exports rose from 1.8% to 12.8% during the same period.
The monthly Press Information Bureau (PIB) release highlighted second consecutive monthly decline in total GST collection at Rs. 947 bn in November (Rs. 976 bn in October). After accounting for refunds, on a cash accounting basis, the November collections would likely be around Rs. 870 bn, implying a 9MFY19 run-rate of Rs. 896 bn.
GST revenues continuing to remain well below budgeted targets, it will be difficult for the central government to meet its Gross Fiscal Deficit (GFD)/GDP target of 3.3% without expenditure cuts which are very likely over the next few months.
Assembly poll results were announced for 5 states with Congress emerging victorious, in 3 BJP incumbent states (MP, Rajasthan, Chhattisgarh), while Telangana went to Telangana Rashtra Samithi (TRS) and Mizoram to Mizo National Front (MNF). The central government may announce a few populistic policies and temporary curb expenditure on roads and defense to balance the gross fiscal deficit.
On the back of persistent undershooting of headline Consumer Price Index (CPI), lower oil and stable currency we see reasonably stable macro situation, but political uncertainty and impact of slowing global economy are key things, which could affect India going forward.
Equity Market
Indian equities stayed flat in December, despite crude falling below $55 as global-risks weighted on the sentiment. On the political front, assembly poll results were announced for 5 states with Congress emerging victorious, in 3 BJP incumbent states (MP, Rajasthan, Chattisgarh), while Telangana went to Telangana Rashtra Samithi (TRS) and Mizoram to Mizo National Front (MNF). However, reports of government contemplating several incentives for farmers kept market upbeat in rural demand centric companies/sectors. On the monetary front, RBI held off on the rate hike once again. In a surprising development, RBI Governor Urijit Patel tendered his resignation with immediate effect, and the Government immediately appointed Shaktikanta Das (An ex-Indian Administrative Service officer who has served under various government ministries) as the new RBI Governor, which was taken positively by the markets.
In terms of sector level performances, the best performing sectors were BSE Power (+4.6%), BSE Oil & Gas (+3.8%), BSE FMCG (+1.6%), BSE Bankex (+1.4%), while the sectors which were major laggards were BSE Healthcare (-2.9%), BSE Tech (-1.5%) and BSE Auto (-0.3%). Foreign Institutional Investor (FII) Dec activity was slow but stronger than that of Domestic Institutional Investors (DIIs). In January, Q3 earnings will be the key monitorable.
Even as global markets are reflecting anxiety on US growth prospects, our in-house view remains that of steady expansion with low inflation leading to lesser market volatility than in 2018. The US monetary policy is becoming less accommodative, but the Fed is “not tightening”, only “normalising” policy, which can still support economic and business expansion for a long time. Near-term, however, the key monitorable will likely be US-China trade relations, which at the margin seems to be improving gauged by the developments over the past few weeks. The Indian markets will probably tread cautiously until its national elections in April-May 2019 even as more near-term attention turns to the Q3 corporate earnings season during Jan-Feb 2019. Recent improvement in macro factors such as oil and currency, should support overall market valuations and protect the downside.
Incrementally, we do turn constructive on the market from an opportunity standpoint; particularly in the mid and small cap segment given meaningful valuation corrections in several good quality businesses.
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 strengthening a pro-cyclical stance and some portfolio shifts to capture a potential industrial/manufacturing recovery are being undertaken. 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 yields of longer tenor bonds cooled off further in December’18. The month of December will be recorded in history as it marked the resignation of Urjit Patel as Governor of RBI and the government named an ex bureaucrat Shaktikanta Das shortly after. The bond prices continued to appreciate. The reasons for the price appreciation are as follows:
- Drop in the international oil prices, led by buildup of inventory and increased supply
- Sustained decline in headline inflation in India, Consumer Price Index (CPI) moved lower to 2.31%
- Stabilization of INR vs USD and EUR
- Monthly calendar of OMO announced by RBI for Oct, Nov, Dec and later for Jan’19
- Contraction in trade deficit
- Reversal in portfolio flows from overseas investors
- Rally in US treasuries leading to flattening out of the yield curve
The 10 year benchmark declined to a low of 7.25% in the month of Dec’18 from 7.60% previous month. The 10 year benchmark sovereign yield came off from an intra-day high of 8.22% in Oct. The drop in international oil prices by over 30% from the peak has been the biggest trigger for this rally in the bond market. Risk aversion post the default of IL&FS led to increased demand for sovereign bonds leading to spread widening in credits. As the rally in sovereign have now slowed there has been some pick-up in demand for AAA PSU bonds as the next best credit worthy bonds. Based on the market movements it appears that the market participants have started to neutralize the additional rounds of rate hikes that it had earlier priced in, post the rise in oil prices and stance change from RBI. Now that there has been a sharp drop in oil prices and headline Consumer Price Index (CPI) the bond yields have started to soften.
Now it remains to be seen if the MPC members change the stance of the monetary policy to neutral or accommodative and how soon. With the change in the RBI Governor and increase in the frequency of communication by RBI with the market, the market is trying to gauge the new Governor better. With the sharp drop in the headline Consumer Price Index (CPI) to 2.3%, the average real rates have widened lose to 400bps (2 times of the average).
The headline inflation data moved lower over the last 3 months largely led by the drop in food prices and now being assisted with declining international oil prices. The OMO of Rs. 36,000 crore in Oct, Rs. 40,000 crore for Nov’18 and Rs.50,000 cr for Dec’18 and now Rs. 50,000 cr for Jan’19 has improved the market sentiment.
The money market at the shorter end was under huge liquidity stress post the default of IL&FS and its group companies in Sept’18 and downgrade of its credit rating to D from AAA in a matter of weeks. Ever since the default, government had desired that RBI would infuse liquidity into the markets in a targeted manner for the NBFCs and HFCs. However, so far RBI has not relented and only infused liquidity through the OMO route by buying gilts. This has increased the liquidity in the hands of the banks. It is expected that the excess liquidity in the hands of the banks will get onward lent to the corporates including NBFCs and HFCs. However in the absence of commensurate risk appetite the flow of liquidity into the affected sector is ebbing and the credit spreads have widened by over 100bps in the last few months. Of late, RBI has modified the policy around sell down of assets by HFCs & NBFCs. These measures have opened up lines of liquidity for such entities and have led to some drop in their borrowing cost.
In the given market conditions, we urge investors to remain cautious and pick fund duration aligned to their investment horizons and progressively start looking at moderate duration as the stage is set for some drop in policy rates over 2019. As the new RBI Governor has also spoken about need for higher growth, we will not be surprised if there is a quick change in the policy stance and lower rates beginning Feb’19.
We do hold on to our stance for a need for tighter real rates and endorse efficient allocation of capital and savings/investment. 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 December 2018
Next Update On: 15th January 2019
Update Frequency: Once Every Month
