By: Navneet Munot CFA, Director IAIP and CIO SBI MF
There has been a lot to cheer in India – the ’Mangalyan’ in Mars, Gold in Hockey at the Asian games, Standard and Poor (S&P) improving outlook on India’s credit rating and a rousing reception to the Prime minister in the USA. The Chinese premier expressed deep interest in investing in India’s infrastructure while savoring Gujarati snacks with Prime Minister Modi on swings at the Sabarmati River Front. Another boon for India has come in the form of falling global commodity prices as a result of a slowdown in the rest of the world, particularly China, which has pursued an investment-led growth model and has been guzzling industrial commodities at break-neck speed.
Campaigns like ’Clean India’ and ’Make in India’ have created lot of buzz. Whether it is their conviction or compulsion, we believe, this government is unlikely to announce any ’big-bang reforms’ but would stay firmly on the path of improving India’s ranking on parameters such as ’ease of doing business’ and ’human conditions index’. The government’s priorities are things like skill development, financial inclusion, e-governance, infrastructure improvement while legislative reforms like overhauling the labor laws will have to wait. Another area of focus would be on reducing the friction due to conflict or lack of co-operation at inter-departmental levels or between the Centre and States. The financial inclusion plan will expedite the direct benefits transfer (DBT), improve tax revenues (as a greater part of economy comes to mainstream) and will help in promote household savings and channelizing it into productive assets. The clean India campaign will not only help improve general hygiene and female literacy (toilets in schools lead to higher participation) but will also unleash the humongous potential in tourism. The thought process behind all these is that India needs to leverage the full potential of its demographic dividend by improving the social infrastructure, skilling young people and creating jobs that would lead to higher disposable income and spending. Eyeing this opportunity, more investments would come, in turn leading to creation of more jobs and incomes thus setting a virtuous cycle in motion.
There are challenges. The judicial pronouncements on the coal block allocation would surely pave the way for a fair and transparent way of natural resource allocation but has created some uncertainty in the near term. The world isn’t in great shape either; geo-political risks abound with Middle-East and Russia-Ukraine still vulnerable. Tear gas on protestors in Hong Kong makes one nervous about the sign of things in this part of the world. Euro-zone, Japan, China and several other emerging economies are finding it tough to keep the growth momentum on. Expected normalization of US monetary policy can reduce the risk-appetite, in general, with larger impact on emerging markets like us. Any negative surprise in the upcoming State elections may impact business and investor sentiments. While we firmly believe that the worst of macro is behind us, the pace of recovery needs to be watched. The corporate balance sheet in India seems to be in good shape but beneath it is a big divergence with a section that is quite strained. Slowdown in credit growth also reflects that banks have finally shut the taps for those whose balance sheets are over-extended. We also have to reckon the possibility of large supply of equity issuances. While India surely looks like a favored investment destination in a growth constrained world but there is no reason to be complacent.
Given that equity valuations are marginally above the historic average, we expect the markets to consolidate at current levels. Notwithstanding the near term challenges and expected volatility, India looks well positioned to deliver a sustainable bull run in the long run on the back of stabilizing macro, reviving corporate earnings growth, near-average valuations, and better liquidity both from foreign as well as domestic investors.
The ’way of doing business’ is undergoing a shift with a new model of natural resource allocation, impact of technological changes and greater connectivity and a more agile, informed and demanding customer. There are multiple growth drivers at play such as revival in manufacturing and exports, growth in consumption both at the higher end (premiumization) and at the bottom of the pyramid, penetration of technology with higher connectivity, improvement in farm productivity, etc, that will open up new frontiers for businesses. This is a new growth cycle for India and there would be another set of players that can gain scale in revenues and profitability; who have established the right business model to capitalize on upcoming opportunities. While keeping an eye on macro developments and identifying emerging themes and shifts, our greater focus remain on bottom up stock picking, we believe, is the best way to generate alpha on a sustainable basis.
With the RBI adopting the inflation glide path targeting 6% CPI inflation by January 2016, the monetary policy stance in the bi-Monthly review was on predictable terms. The Central bank continues to remain cautious about the medium term 6% target even while acknowledging that upside risks to inflation have reduced over the last few months. The access to refinance under Export Credit refinance has been further reduced to 15% of eligible export credit. The hold-to-maturity (HTM) portion for banks have been reduced to 22% from 24% in a staggered manner till September 2015. The HTM ratio has now been aligned with the actual SLR ratio that has been cut earlier.
Average overnight rates eased during the month as government spending eased the liquidity shortage that has persisted since July.
In an environment of a stronger dollar globally and with RBI determined to increase forex reserves, the rupee is likely to stay under pressure despite robust capital flows. But, it should perform relatively better than its peers.
Strong FII demand with over USD 20 billion of flows, till date, subdued credit off take and declining commodity prices have supported a softening trend in bond yields recently. This has also been supported by the government maintaining its commitment to fiscal consolidation and also announcing reduction in auctions and doing buybacks of securities. The RBI is likely to remain on a prolonged pause for the near term with the policy stance likely to be shaped by forward looking estimates on the trends of CPI inflation. Near term market trends could be increasingly dependent on trends in global rates and flows as well as the evolution of inflation direction.
We have been running moderate duration in long term funds with a positive medium term view. While yields look attractive from a historical perspective and relative to other countries, it may be a while before RBI considers monetary easing in the backdrop of the new monetary policy framework.