Indian Markets - An Overview

Market update

The month of February saw the Indian Market consolidating itself over the gains of the previous month. The S&P CNX Nifty gained 4.49% and 3.58% in US$ and INR terms respectively. The CNX Midcap Index gained 9.48% and 8.52% in US$ and INR terms respectively. The broad based CNX 500 Index returned 5.65% and 4.72% in US$ and INR terms respectively. The INR appreciated against the US$ by 1.49%.

Liquidity flows into emerging markets remained robust. India saw Foreign Institutional Investors (FII) flows in excess of US$5bn during the month thereby taking the YTD flows to more than US$7bn. The probability of a higher quantum of Long Term Refinance Operation (dubbed LTRO II) to be announced by ECB by end February also kept the  market mood buoyant. In its December 21st LTRO (LTRO I), around 523 banks bid to borrow €489 billion ($657 billion) in three-year loans fixed at its refinance rate of 1%. Finally on 29th February 2012, the amount came in at €529bn with 800 bidders with a rollover (of existing short term borrowings from ECB) of €222bn.

The domestic Wholesale Price Index (WPI) Inflation (down to 6.6% in Jan 2012 from 7.47% in Dec 2011) has for the second time in so many months shown a declining trend and has come below the central bank’s targeted level of 7% by March 2012. A new series on Consumer Price Index (CPI) has been introduced. The CPI for Jan 2012 came in at 7.6% yoy. In future, it will provide an additional data point to monitor inflation. Though the earlier CRR (Cash Reserve Ratio) cut of 50bps has eased the domestic banking liquidity a bit, we expect another cut in CRR in March 2012 to further ease the situation. The Index of Industrial Production (IIP) for Dec 2011 came in lower at 1.9% (5.9% in Nov 2011) and is not providing any clear signals of economic recovery. The Q3 GDP (Oct-Dec 2011) release at 6.1% (6.9% for Q2) has indicated a marginal slowdown sequentially. Though we expect the RBI to start reducing the policy rates (100 bps in FY12-13) by April on the back of falling inflation and sagging growth, it would be a positive surprise for the market if the central bank takes this step along with CRR reduction in March itself.

The Prime Minister’s Economic Advisory Council (PMEAC) expects the FY12 GDP to grow at 7.1% and that of FY13 at 7.6% to be mainly lead by Industrial recovery (7.2% FY13 from 3.6% in FY12). It projects FY13 inflation between 5.5-6% and sees a marginal improvement in both Savings (from 31.6% to 32.5%) rate and Investment (from 35.2% to 35.5%) for FY13. The PMEAC expects the gross domestic capital formation growth at 9% from the current 5.4% (FY12 E) and also projects the Current Account Deficit (CAD) to GDP lower at -3% (FY13E) from current FY12 E of -3.6%. The Council prescribes that the government has to clearly and unambiguously show that fiscal consolidation is being done earnestly. It also specifies that the government should set ambitious targets in capacity creation and operational performance for FY2013E to boost economic activity.

During the month, the Government of India took an initiative to revive the Public Sector (PSU) Dis-investment process by announcing the auction of ONGC shares amounting to nearly US$2.5bn to part fund its US$11.5bn planned disinvestment for FY12. Further, the Supreme Court verdict on the 2G has cancelled the Telecom licenses of new players and re-auctioning of freed up bands in the immediate future. This would augment government resources and may ease the widening Fiscal Deficit (already 5.4% above FY11 Budget Estimate) against the targeted 4.6% of GDP for FY12.

The curtain on the Q3 result season has fallen. Overall the top-line and earnings growth surprised markets positively. The Oil and Gas sector results were much better than expectation due to higher than expected government subsidy support. The Automobiles, Information Technology, Cement, Pharmaceuticals, Fast Moving Consumer Goods (FMCG) sectors in general came out with higher than 15% earnings growth. The results of the Telecom, Power Utilities, Capital Goods and Infrastructure were a disappointment on expected lines due to margin impact in a high interest rate environment. Over the next two quarters we expect a substantial improvement in the results of interest rate sensitive sectors on the back of a benign interest rate environment.

Market Outlook

The outcome of the polls (expected by 6th March 2012) to the five state assemblies’ may have an impact not only on the political re-alignment of the parties at the center but would also have an impact on future economic policies of the government. Hence we believe the markets may be reacting to the news on the political front. We expect certain decisions like the fuel price hike (both diesel and petrol) may be deliberated upon immediately (post results). The recent surge in the global Oil price due to political turbulence in the Middle East has put more pressure on the need to ease the burgeoning oil subsidy through price de-control.

Post the election results, the Union Budget on the 16th March 2012 would assume significance given the current fiscal indiscipline of the Government. We expect further widening of tax net (both direct and indirect), PSU dis-investment and targeted subsidy mechanism to strengthen the exchequer. We also expect higher expenditure on Infrastructure development to revive economic growth and improve the investment climate. We expect social spending to continue to support inclusive growth.

In the light of the above two events unfolding in March, we expect higher volatility in the markets in the near term.  Although any positive developments on the outcome of the polls, would be a sentiment booster, the budget would provide more clarity on various macroeconomic concerns. The foreign investor’s confidence could get boosted if they see Government policy initiatives on better fiscal management. With abundant global liquidity, receding concerns on global economic slowdown, the money flow into emerging markets in general and into India in particular can continue in 2012.

Across our portfolio strategies, we would remain nimble footed and make necessary changes both from a top-down and bottom-up basis to reflect the changes in the macro and micro environment post the Union Budget. Currently we continue to believe in the domestic Consumption, Finance and Infrastructure themes in various degrees apart from India’s proven outsourcing capabilities in the IT and Pharmaceutical space.

As of 29th February 2012, S&P CNX Nifty and CNX Midcap traded at 13.3x and 12.4x FY13 EPS respectively (Source: Bloomberg consensus estimate).