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Indian Markets - An Overview

Indian Markets - An Overview

Financial markets in India are going through a challenging time with worries on deficits, economic slowdown, and global issues. The biggest worry currently is the INR weakness and volatility. Both RBI (Reserve Bank of India) and the government are taking a series of measures to arrest the same. Some of these measures while having their desired impact in the medium to long term, may have unintended consequences in the near term. After tightening measures announced by the RBI to rein INR volatility, India bond market, especially longer dated bond, suffered the unintended consequences and the 10-year bond yield surged to 9.4%, the highest since 2001. Though the RBI intervened through open market purchase operation, the yield still remains at around 8.5%. The rupee, due to outflows on both equity and debt markets and sell off in global emerging markets, also weakened and continued to hit record lows. The failure of RBI’s measures to halt the depreciation of the rupee, fear of Fed tapering, increased tension in Syria, and higher than expected July WPI inflation number weighed on the equity market and Nifty lost 12.85% (in USD terms) for the month.

While some part of India’s problem is related to global worries, a large part of the problem is self-inflicted. Recently we have acknowledgement from the policy makers on these issues and are seeing corrective measures being taken. The new RBI Governor, Raghuram Rajan, will assume office on 5th September 2013. We do not expect RBI to reduce policy rates in the current year. The new Governor will have to balance the impossible trinity of managing growth, inflation and the INR. The issuance of a sovereign bond along the lines of the earlier issued India Millennium Deposits (IMD) or Resurgent India Bonds (RIB) is a possibility.

Key developments

  • Fear of Fed tapering of stimulus continued to be the main worry for Emerging Markets and this led to big losses in both their equity and currency markets. The period also saw 10-year US government bond yield rise to around 2.8% from the lows of 1.6% reached in May this year. Escalation of conflict in Syria at the end of the month prompted oil price (Brent) to rise to USD117/bbl (v/s USD107.7/bbl at the beginning of the month). However, Chinese macroeconomic data was better than expected and that has given some respite to the metal sector.
  • The period saw the release of the GDP growth number for the quarter ending June 2013 (Q1FY14) which stood at 4.4% YoY, the lowest growth in 17 quarters since the Lehman crisis low of 3.5% of 4QFY09. The slowdown is all pervasive barring the bright spot in agriculture on the back of good monsoons. We are also cutting our GDP growth estimates for FY14 to around 4.5% from earlier expectations of 5% which is well below India’s potential growth rate.
  • The government and the RBI announced a series of measures to support the Rupee. Hiked import duties on gold by 2% to 10% respectively; prohibited imports of gold coins and medallion; reduced the limit for Overseas Direct Investment (ODI) under automatic route to 100% of the net worth of companies (from 400% previously); reduced the limit of remittances that can be transferred abroad by resident individuals to USD75,000 (from USD200,000 previously) per financial year. In addition, the government also announced the opening of forex swap line with state-owned oil companies to meet the dollar requirement for crude oil imports. We have revised our INR assumptions and believe that it may trade in a wide range between 60-68 to the USD (58-62 earlier) and average ~62/USD in FY14 (59 earlier). While the INR could overshoot the band, it may revert back to this trading band over a period of time.
  • On the positive side, Trade balance numbers continued to see improvement - Export rose by 11.64% YoY while import were down YoY, leading to July trade deficit at USD12.27bn (v/s USD12.24bn in June), down 29.8% YoY. Given the recent measures and the slowdown in the domestic economy, we see this number potentially coming down further in coming months.
  • The period also saw Raghuram Rajan being appointed as the next RBI governor to replace current RBI governor, Duvvuri Subbarao, whose tenure will end on 4th September 2013. Market reaction is positive given the stature of Rajan as former and youngest Chief Economist of IMF where he is widely credited for his warning of impending crisis in the financial sector.
  • One of the key developments in recent weeks has been the passage of Land Acquisition Bill and National Foods Security Bill by the parliament and this has been met with scepticism by both investors and industry. These bills, while the intend is in right spirit, will increase the subsidy burden on the already strained economy. Land acquisition will potentially lead to slower investment cycle when a revival of the same is deeply desired.
  • Inflation number (WPI) for the month of July stood at 5.79% (v/s 4.86% in June), higher than expectation of 5%. However, core inflation though up remained benign at 2.4% (v/s 2.1% in June).
  • Corporate earnings - The first quarter earnings season has ended and broadly the corporate results were in line with estimates. On sectoral basis – IT, Pharmaceuticals FMCG and the Media sector saw upgrades in earnings while Banking, Capital goods and the Cement sector have seen downgrades.

Market Outlook and Valuation
Every crisis brings an opportunity. If one reads the media bytes and headlines in India, one perceives all round gloom in India. However the rural economy is going through good times. We have had one of the best monsoons in recent years and the clear outcome of that will be a strong agricultural growth. Given that the water tables would have been augmented, even Rabi (winter crop which is the more important crop) will be most likely much better. This will definitely cushion the slowdown as two thirds of India still lives in rural areas.

Additionally while the scenario looks like a repeat of Lehman crisis, the global economy is at this juncture on a recovery path. US has seen GDP growth recovering and recent pointers suggest that even Euro zone is stabilizing. This augurs well for exports, particularly software and to a certain extent pharmaceuticals where we as a fund are also overweight. INR depreciation could well be part of the solution by making domestic produce more competitive versus imports and also slowing down excessive / wasteful consumption of imported goods and this could lead to current account correction. Recent trade data points to the same. We have also seen in past that in crisis, tough policy measures are taken by policy makers. We are already seeing ease in the FDI rules in various sectors and oil related subsidies being addressed. Recently, the Cabinet Committee on Investment (CCI) has expedited clearances of 36 infrastructure projects worth about INR1.8trn (USD27.3bn) across various sectors. The concerned ministries have been directed to expedite clearance of these projects.

At the current juncture post the INR and the market correction, as of end of August 2013, the Indian equity markets are trading at 11.1x one year forward earnings (Nifty – Source: Kotak Institutional Equities). On price to book we are at the lower end of the historical average. Post the recent correction, valuations in several good companies are beginning to look reasonable. This should, over time, attract equity flows into India once the INR stabilizes. So, while not ruling out volatility driven by both global and local factors, one should look to add exposure.

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