Market Update
Macro Economic Review
Overall the month of March was a good month for Indian equity and fixed income markets. Nifty rose 7.8%, 10 year government bond yields rallied by 7 bps and INR gained 2.5% against the USD. This was to a large extent helped by Foreign Portfolio Investor (FPI) inflows of USD 8bn in March 19. With the opinion polls on India’s national elections no longer pointing to a hung parliament, the overlook for India has turned positive.
Inflation for the month of February came at 2.57%, primarily led by increase in food price. Core inflation eased to 5.09% from 5.14%. RBI lowered its inflation forecast for FY20 to around 4%. Meanwhile, oil prices have continued to climb with brent crude price up 4.5% for March and 27% for the quarter. This may show up in inflation numbers for H2 FY20.
India’s current account deficit (CAD) came at US$ 16.9 billion (2.5 per cent of GDP) in Q3 of 2018- 19 increased from US$ 13.7 billion (2.1 per cent of GDP) in Q3 of 2017-18, but moderated from US$ 19.1 billion (2.9 per cent of GDP) in the preceding quarter. The widening of the CAD on a year-on-year (y-o-y) basis was primarily on account of a higher trade deficit at US$ 49.5 billion as compared with US$ 44.0 billion a year ago.
The Q3FY19 GDP growth slowed to sub-7% levels (6.6%). Growth typically tends to slow in the quarter or two before national elections as the private sector postpones spending plans and there is some restraint from the consumer as well. Consensus is for GDP to grow around 7.3%-7.4% for FY20. The agriculture sector grew at 2.7% in Q3 compared to 4.2% in Q2, while manufacturing grew at 6.7% in Q3 compared to 6.9% in Q2. Consumer spending slowed to an 8.4% rise annually in Q3, compared to a revised 9.9% rise in the previous quarter. Gross fixed capital formation – which include infrastructure spending – rose 10.6% compared with a revised 10.2% annual increase in the previous quarter.
March GST collections were strong and came in at INR 1 lakh crore. The February direct and indirect tax collections fell short of budgeted numbers and so some expenditure cuts will be needed to meet 3.4% fiscal deficit target for FY19.
Given the tight domestic liquidity conditions in March and limited room for Open Market Operations, RBI announced 3 year FX swap for $5bn. This was primarily designed to infuse INR liquidity. The announcement helped to attract bids for $16bn and decreased forward premiums in the FX markets thereby lowering hedging costs.
The Finance Ministry has announced a heavy borrowing calendar for 1HFY19 with 62.3% of full year – i.e., Rs.4.4trn of G-Sec borrowing to be done by September 2019, versus Rs. 2.7trn (49% of full year). This may continue to weigh on the long end of the yield curve.
On the global front, US Federal Reserve Bank’s signal that it may not raise rates this year augurs well for emerging markets. However, if the reason for the easier Fed policy is slowing world growth, then the change in policy could impinge upon growth.
Overall, the month has seen a moderation in growth with inflation still below 3%. Global growth has also moderated with policy stimulus needed to stimulate growth. Higher oil prices may start to put pressure on the current account deficit. But the key focus will be on the upcoming general elections in April-May 19.
Equity Market
Indian markets (Sensex +7.8%) reversed Feb’s weakness with renewed foreign inflows and sentiment boost from latest opinion polls tilting further in favour of incumbent BJP. Further, dovish outlook from the US Federal reserve (despite rising risks of a global slowdown) boosted FPI interest in India which remained robust with inflows nearly doubling month-on-month, while domestic investors were sellers as they faced significant outflows. The Election Commission announced polling dates for the 17th Lok Sabha to be conducted in 7 phases between 11 Apr and 19 May, as political parties actively announced candidates contesting for the 543 seats of Parliament. Ahead of central bank’s policy review in early April, markets are expecting a further rate cut while debating over the magnitude of the cut. In terms of Economic indicators, barring consumer credit growth, most other indicators like auto sales, consumer durable production and air passenger growth continue to weaken sharply.
In terms of sector level performances, the best performing sectors were BSE Realty (+15.7%), BSE Bankex (+13.7%), BSE Consumer Durables (+11.4%) while the sectors which were major laggards were BSE Auto (+0.1%), BSE Infotech (+0.2%) and BSE Tech (+0.4%). FPIs bought equities worth US$4.8 bn during the month while DIIs sold US$ 2 bn worth of equities.
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. Since the last few months, we had turned constructive on the Indian equity market from an opportunity standpoint; particularly in the mid and small cap segment given meaningful valuation corrections in several good quality businesses. Our overall market view is still constructive, even though we would like to advise clients to recalibrate their near term or short-term return expectations post the recent rally across market caps as valuations have now turned fair from attractive earlier.
Our positive outlook is premised on improving macro factors - controlled inflation, stable commodity prices and currency, improving asset quality and credit growth cycle and likely moderation of interest rates. We think the modest improvement seen in corporate earnings last quarter have now got the necessary conditions and building blocks to gather strength in coming quarters which may be further aided by better consumer sentiment post the election event.
Besides, we regard global macro as stable and turning favourable for EMs in general versus 2018 as global interest rate cycle once again turns accommodative and US-China trade conditions improve. This should be supportive of liquidity flows to emerging markets which in turn may support valuations. We do not rule out time corrections to the market post recent sharp rally but also advise against excessive pessimism given earnings cycle once it improves this year, can well extend into the next couple of years.
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 month of March’19 was quite eventful. We saw a series of measures from RBI in order to infuse long term durable rupee liquidity into the fixed income market.
The measures included:
- Gsec purchase through OMO – Rs 25,000 crore
- Opening up of VRR (voluntary retention route) for foreign investors for both gilts and corporate bonds – Rs 75,000 crore
- Long term repo for upto max duration of 2 months – Rs 1 lakh crore
- 3 year USD INR swap - $ 5 bn ( approx. Rs 35,000 crore)
In addition to the above measures, the month witnessed steady and strong portfolio flows of Rs 47,600 crores from foreign investors. Such strong flows were last seen in 2014.
While all these measures pushed rupee liquidity into the market, the fears of an excessive borrowing calendar over FY20, has still not diminished. In general, the overnight rates stayed below the repo rate of 6.25% for most trading days in March’19.
Seasonally, the month of March generally witnesses liquidity tightening, since most entities conserve cash and the advance tax payments also suck out liquidity amidst drop in government spending in the last month of the FY. This year was divergent due to the above measures taken by RBI.
While most market participants are expecting another 25bps rate reduction in the April’19 monetary policy, we feel the scope and need for rate reduction is more than 25bps. So far, the bond yields have not moved in line with the market expectations. Hence, the drop in bond yields can be significantly large in such an event, however any repo rate reduction needs to be matched by dovish stance and infusion of liquidity for any material softening of bond yields.
The sudden change in the stance of Federal Reserve Bank, US (FED) on rate hikes and the subsequent softening in the bond yields in US and Europe has obviously tilted the balance in favour of EMs. While the expected weakening of USD post the slowdown in US and the confusion around Brexit has not pulled down the crude oil prices yet, it remains largely a fundamental possibility over 2019. The possibility of continuation of output reductions by OPEC nations has kept the oil prices elevated but still over 20% lower than the peaks of 2018.
On the global front, Fed became very dovish on rate as well as balance sheet reduction front. With inflation (core CPI 2.1%) around FED’s target range and financial conditions in US tightening due to weak equity and credit markets, FED said they will likely stop balance sheet reduction later in the year and will be patient on interest rate rises. Forward rates curve in US is currently pricing no interest rate rises in US for balance of 2019. This clearly will be helpful for Emerging Markets and help to contain the rapid rise of USD.
Over the last few months, incrementally based on the data print, we have been bullish on interest rates and 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.
Outlook
We think GDP growth is slowing down on back of sluggish global growth and slowing domestic consumption. On inflation front, we think headline CPI for CY20 should be comfortably within 4%. Thus, with a slowdown in growth combined with high real interest rates, RBI is likely cut rates so as to push lower rates into the economy. However, the drop in repo rates do not guarantee lower borrowing cost and hence we feel that RBI will remain proactive to infuse liquidity in order to bring down the deposit rates of the banks so that they can eventually offer loans at a cheaper rate.
Additionally certain public sector banks which were under prompt corrective action (PCA framework) have now been remediated and should be able to lend thereby improving availability of credit.
We also think FPI flows in debt market would continue in the April quarter (with some swings around the general election period). Thus, we think the path is set for yields and credit spreads to compress, albeit with bouts of volatility. In the given market conditions, we urge investors to start selecting funds in alignment with their investment horizon and selectively longer, depending on their individual risk appetite. Hence some additional duration over the investment horizon should work in favour as the risk return matrix is tilted in favour of lower rates. The risks to this view emanate from higher government borrowing calendar of FY20.
Last Updated: 15th March 2019
Next Update On: 15th April 2019
Update Frequency: Once Every Month
