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Investment Insights

Suyash Choudhary

Our updates on RBI’s intervention to soothe bond markets are beginning to resemble a well received movie franchise; given the number of sequels. Be as it may, the RBI struck yet again yesterday (thrice by our count now; refer ‘RBI measures today”, dated 20th August and “RBI gives a yield signal; again” dated 3rd September for the other 2). Since the last monetary policy review when the central bank threw in a surprise repo rate hike, bond markets have been in a tizzy again with 10 year yield rising by 60 – 70 bps over the past few sessions. Even this doesn’t capture half of the total pain, given that the 10 year is about the only security that deals in the market with any reasonable volume these days. Illiquidity and term spreads have both continued to widen reflecting generalized lack of confidence in the market. Furthermore, 27% of the last auction devolved on primary dealers indicating muted appetite.
 
The RBI in its short press release yesterday states that ‘liquidity conditions have been tightening as reflected in the hardening of yields in the government securities market due to uncertainties around the Government borrowing programme for the second half of 2013-14 as well as the prospective effects of banks’ half-yearly account closure, the seasonal pick-up in credit demand, festival-related demand for currency and sluggish deposit growth. The Reserve Bank is closely and continuously monitoring liquidity conditions and will take actions as appropriate, including open market operations, to ensure that adequate liquidity is available to support the flow of credit to productive sectors of the economy’.
 
We would somewhat differ with this assessment and rather attribute movement in yields to the following:
 
1. While it is true that the RBI cut MSF by 75 bps in its last review, it hiked repo by 25 bps. The central bank may have believed that this amounts to net easing and therefore bond markets should behave accordingly. We would disagree. The MSF hike was projected as a temporary measure aimed at stemming rupee volatility. This view was endorsed by Raghuram Rajan himself in his earlier avatar as the chief economic advisor (refer http://m.financialexpress.com/news/rajan-rbi-steps-to-stabilise-re-temporary-and-reversible/1146747/ as a sample). In fact the RBI as an institution, in its first quarter monetary policy review had gone so far as to suggest that but for currency volatility, the bias would have been to continue to ease monetary policy. Given that the repo rate is RBI’s primary policy tool and hence has a large signaling effect, a hike in this rate has been justifiably interpreted by the market as a reversal in monetary policy stance. This was bound to increase term premium on the curve as has in fact been the case.
 
2. Since the liquidity steps announced mid-July, the participation of PSU banks in the government bond market has drastically reduced. This category is traditionally the largest participant in the market. Subdued participation from this category has resulted in weak appetite for bonds. This in turn is reflected in narrow secondary market volume, lack of appetite in auctions, and widening illiquidity and term premia for all bonds apart from the 10 year benchmark. The lack of appetite from PSU banks in turn is presumably owing to 2 reasons:
 
a. Average overnight cost of funds has spiked thus rendering government bonds a ‘negative carry’ asset. Besides, as corporate and money markets have virtually frozen, banks have witnessed a rise in working capital draw-down by clients. Because of these reasons, the incentive to buy government bonds has drastically reduced.
 
b. The sudden jump in yields after mid-July has caused a sea of pain to investment books of banks. Even after the transfer to HTM allowed by RBI, banks will still be nursing substantial residual losses. Hence, there is not much incentive to take on meaningful fresh positions in their marked-to-market books till there is a clear direction to the market.
 
We must emphasize that our intent in this particular communication is not to question RBI’s repo move. This was brought about, in their assessment, by the need to signal continued discomfort with still high inflation. However, whatever the assessment, it seems clear that RBI has yet again sent a signal that it is uncomfortable with an excessive rise in long end yields. Market has every right to feel confused given that on the one hand the central bank has hiked repo rate and on the other it seems intent on blocking transmission of this signal beyond a point.
 
From a portfolio perspective our take-away would be as follows:
 
Post the repo rate hike our view was that yields may become volatile as market grapples with uncertainty in the face of bond supply. This has indeed been the case since the policy. With this statement of intent from the RBI, markets may calm down somewhat. However, the problem of absorbing weekly supply may continue till either PSU banks come back to the market more substantially (possible after HTM transfer and start of new quarter) or the central bank follows through with its statement of intent and starts doing OMOs. Over the medium term, we remain positive on the market subject to the government’s fiscal math falling in place. An additional point to note is that with the Fed taper debate beginning, volatility in financial markets across the globe has risen. This is likely to continue so long as the debate remains unresolved. The same volatility is likely to continue to manifest in our own markets as well. Hence , while medium term pay-offs from bond funds may remain intact, investors should brace for more volatility than before in the interim. This fact should guide matching risk appetite and investment horizon to fund selection.
 
 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Suyash Choudhary

Measures:
 
The RBI took the following actions today:
 
1. Reduce marginal standing facility (MSF) rate by 75 bps from 10.25% to 9.5% effective immediately.
2. Reduce maintenance of daily CRR from 99% of requirement to 95% from fortnight beginning 21st September, while keeping CRR rate unchanged.
3. Increase repo rate by 25 bps to 7.5% with immediate effect.
 
Takeaways:
 
1. As measures to compress CAD and secure capital flows are falling in place and the external environment is showing some signs of stability, the bias is to gradually remove the exceptional liquidity tightness measures currently in place. A first step has been taken in that direction today and as rupee gives more comfort (presumably as FCNR flows pick up), the RBI will look to completely do away with the current set of measures. Importantly, this needn’t happen on officially policy dates. In our view, the next partial cut in MSF rate may happen before the next policy date. The intent is clearly to restore the normal functioning of the LAF corridor (where MSF is 100 bps over repo) as soon as possible.
 
2. Given the objective of restoring repo rate as the operative rate, the next assessment that the RBI is making is where the repo rate should be given our local growth versus inflation dynamic. In the central bank’s assessment, there is no doubt that growth is below potential and the output gap is widening. However, it is seeing the balance between the ‘disinflationary’ impact of a widening output gap and expected good harvest versus the potential inflationary impact of rupee depreciation and suppressed inflation pass through (fuel price hike). It recognizes a trade-off between need to anchor inflation and inflation expectations against addressing the fragile state of the industrial sector and urban demand. At this juncture, the RBI is happy quantifying this tradeoff in a 25 bps hike in the repo rate. For the future, the stance is completely neutral and is likely to continue to get calibrated on the evolving medium term trade-offs between growth and inflation.
 
3. With respect to the rupee the RBI assesses that after recent steps taken on CAD and external financing, the focus has turned to internal determinants of the value of the rupee, primarily fiscal deficit and inflation. While not said explicitly, it seems apparent to us that the burden to control inflation will be looked at also from perspective of concrete fiscal control steps taken by the government.
 
Assessment and Market Implications:
 
Going into the policy and basis the joining-day speech of the new governor, it was evident that Rajan would look to simplify the monetary policy framework. In particular, he would not ‘hide behind’ the current high MSF rate to address inflation objectives as well. This has been emphatically adhered to with the governor making a clear statement of intent of restoring the normal corridor of MSF being 100 bps higher than the repo rate. In the same speech, he had also argued for requirement for low and stable inflation in order to preserve the value of the rupee. Our assessment of the growth versus inflation dynamic currently in place suggested that while repo rate cuts were out of the question, there was no strong rationale for reversing the interest rate cycle per se. Our rationale was largely based on the signaling effect it would have for banks’ lending rates especially in an environment of 4% headline growth bound and just ahead of start of busy season on credit. However, while in the policy and in subsequent interactions the governor has shown sufficient sensitivity to growth and has stayed clear of any sort of commitments to further action, in his current assessment he is more hawkish when viewing the growth versus inflation dynamic than we had assessed.
 
The following points need to be kept in mind, in our view:
 
1. Notwithstanding the repo rate hike today, we wouldn’t assess this the start of a new rate hike cycle. Growth impulses remain weak and once the temporary pressures from unseasonal food price spike and rupee depreciation abate, headline inflation should become better anchored as well. Furthermore assuming the finance minister delivers on fiscal compression, this will further dent aggregate demand as well as give RBI more comfort to move to growth mandate (as at least one of the 2 internal determinants of the rupee would fall in place).
 
2. However, what is also true is that in the near term market participants will remain uncertain about direction of monetary policy. This will happen as auction supply resumes from next week. This may keep ‘term premia’ on the curve elevated and volatile. To put it simply, while eventually a 50 – 75 bps spread over repo rate may be seen as enough compensation to buy duration, in the near term market may demand more as incentive to take supply in face of policy uncertainty. This may keep bond yields volatile for longer than earlier estimated. We had increased cash levels in our bond funds going into the uncertainty of the Fed meet and the RBI policy. Given this assessment, we may look to further pare duration tactically in the near term. However, the medium term picture continues to look fairly positive as external account and inflation stabilize in an environment of very weak growth impulses. As mentioned before, a key determinant for the macro-environment and hence rate view will continue to be speedy and substantive action BY measures, rupee, FCNR, soon, possible., the, well., well., well, give, auction, enough, incentive, external, mentioned, policy, participants, we, endorsement, an, such, mayBY measures, rupee, FCNR, soon, possible., the, well., well., well, give, auction, enough, incentive, external, mentioned, policy, participants, we, endorsement, an, such, mayBY measures, rupee, FCNR, soon, possible., the, well., well., well, give, auction, enough, incentive, external, mentioned, policy, participants, we, endorsement, an, such, mayBY measures, rupee, FCNR, soon, possible., the, well., well., well, give, auction, enough, incentive, external, mentioned, policy, participants, we, endorsement, an, such, mayBY measures, rupee, FCNR, soon, possible., the, well., well., well, give, auction, enough, incentive, external, mentioned, policy, participants, we, endorsement, an, such, mayBY measures, rupee, FCNR, soon, possible., the, well., well., well, give, auction, enough, incentive, external, mentioned, policy, participants, we, endorsement, an, such, mayby the government on the fiscal deficit.
 
3. Notwithstanding the signaling effect of a repo rate hike, the fact of the matter (and also emphasized multiple times by governor Rajan in his media interaction) is that the RBI is steadily bringing overnight rates down by cutting MSF. Market can look forward to overnight rate converging to repo rate in the next near term. This will be positive for front end assets in the near term. However, we will not look for too much curve steepening per se given that this is ‘busy season and traditionally issuance pressure is substantial till March.
 
Investor Implications:
 
1. Last month has been very good for bond funds as policy makers have got a grip on the external account and the rupee and market has started to factor in unwind of RBI’s exceptional measures. The repo rate hike today may impart some near term volatility again as participants may appear reluctant to absorb immediate bond supply. We will attempt to adjust duration to near term volatility while keeping overall anchor for the medium term. However, bond fund performances are likely to turn volatile again in the near term.
 
2. As we have maintained over last few months, investors should match risk appetite and investment horizon to product selection irrespective of near term momentum factors for the market. More specifically, while income, dynamic and gilt funds should never be bought with less than 1 year horizon; it doesn’t necessarily imply that all more than 1 year money should come to these funds. For a conservative investor a short or medium term fund may offer the best risk-reward even if they have a multi- year investment horizon. This distinction is especially necessary in the current times of heightened volatility.
 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Suyash Choudhary

In what turned out to be a large positive surprise to global (and especially emerging) markets, the Fed decided to hold back on taper in its meet concluded yesterday. This was against consensus of a USD 10 – 15 bn taper expectation. Although we are observers from afar, we have the following key takeaways from the FOMC statement and the Chairman’s press conference subsequently:
 
1. The Fed seems to be concerned with the tightening in financial conditions over the past few months. This seems chiefly due to a substantial spike in interest rates since expectations of a taper started to gain ground. In their assessment, if this continues it can slow the pace of improvement in the economy and labor markets. However, as seen over the past few months, financial conditions tightening is likely to happen whenever taper talk accelerates; especially as it inevitably leads market to bring forward explicit rate hike expectations as well. Hence, in a way this sharply defines the predicament of planning a QE exit. The expectation of exit may lead to tighter financial conditions which in turn may force the Fed to continue to keep the accommodation in place. Furthermore, the fiscal and debt ceiling debate in US may accelerate from here and can potentially add to financial market uncertainties and further impact expected taper timelines.
 
2. There doesn’t seem to be any ‘clinical’ linkage of taper to explicit unemployment level targets. Thus for instance, the earlier indication that taper may be complete by mid next year coinciding with an unemployment rate of 7% seems more as a general guidance. This is especially the case since unemployment rate is being affected by the labor participation rate as well which, as per the Fed’s judgment, has both a structural and a cyclical element. While the Fed cannot do anything about the former, the latter has a part to play when looking at unemployment rate. Hence, in all likelihood, absolute jobs added, general economic rebound, as well as whether inflation is beginning to catch up to the Fed’s target will all have a role to play when deciding on future pace of taper. Suffice it to say that this injects considerable uncertainty and subjectivity to the whole process. Given the interpretation involved, the change in Fed leadership assumes a lot of importance from perspective of continuity. In this regard, the exit of Summers from the race for Fed leadership and the current vice chair Yellen coming back as a front runner has been a source of immense comfort to markets.
 
All told, the Fed announcements yesterday come as an unequivocal dovish signal for the market. Post the event, most expectations for taper have been pushed toward December and beyond. From the perspective of our markets, this comes as a major relief and adds significantly to the positive news flow that has been in place lately. To recap, India has seen the following positive developments over the past few days:
 
1. The geo-political risk around a potential US strike on Syria has abated for the time being with Russia initiating a diplomatic process. This has led crude oil prices lower which otherwise could have been severely damaging for our twin deficit problem.
 
2. After struggling on this issue for a while, India policymakers have finally unveiled credible dollar flow measures around FCNR deposits and overseas bank borrowings (pls refer our note ‘A fistful of dollars’, dated 11th September for details). These should ensure USD 10 – 15 bn additional dollar inflows over the next couple of months.
 
3. Anxiety over continuity in Fed leadership has been substantially reduced with Summers pulling out of the race. Additionally, yesterday’s Fed meet has reduced the near term taper overhang. This should lead some portfolio flows back to emerging markets; hence further bettering dollar flows into our market in the near term. These are substantially positive for the rupee and views of sub 60 versus the dollar have started abounding since morning.
 
4. An additional positive factor being talked about (strictly in the realm of speculation currently) is India’s inclusion in global indices. This will be positive both for dollar flows as well as for a new source of additional demand for our government bonds.
 
These said, the 2 uncertainties that remain are with respect to:
 
1. The new RBI governor’s stance on monetary policy. This will get substantially clarified tomorrow when Raghuram Rajan presents his maiden monetary policy. Market will look for some phased rolling back on liquidity measures now that there seems to be near term stability in the rupee. We would expect the roll back to happen potentially anytime between now and the busy season credit policy due late October. The governor may want to wait till at least some dollar inflows with respect to recent relaxations actually come in before substantially relaxing these measures. On the other hand, a prolonged squeeze in an underlying weak growth environment cannot be very desirable. Noteworthy in this regard is SBI hiking its lending rate, albeit by a token amount.
 
2. The largest remaining near term uncertainty in our view, is with respect to the fiscal deficit. As we have noted on multiple occasions before, this seems like the weakest link to us at this moment. Despite continued assurances from the finance minister and a token austerity measure announced yesterday, big ticket items on this count continue to be elusive. Thus the parliament session is long concluded but a dilly-dally on fuel prices continues. Also, given the continued revenue slowdown (September advance tax collections have grown in single digits apparently), more meaningful expenditure cuts will need to get announced soon for deficit targets to get taken seriously by the market. Hopefully, the window of stability provided by recent local and global measures will be used proactively by the government. If so, then India macro will look substantially better and provide a conducive environment for a further interest rate rally in the medium term.
 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

Tag:

Suyash Choudhary

The month was marked with gut-wrenching volatility in local financial markets as the generalised aversion to the more vulnerable emerging markets continued in the context of ongoing fears with respect to Fed taper. Within this framework, India bore a particularly heavy brunt as recent measures with respect to capital flows were variously considered either insufficient or regressive. It is true that the finance minister committed to compressing current account deficit to USD 70 billion this year (from USD 88 billion last year) and announced steps amounting to USD 11 billion worth of capital flows. However, most of the capital garnering measures pertain to additional bond issuances and external borrowings by PSU entities. There are two problems with these measures: One, these PSU entities have anyway been borrowing off-shore and to that extent the finance minister has not really outlined an additional step with respect to capital flows as far as this is concerned. Two, the market for off-shore borrowing is getting more challenged and there is deep suspicion on whether the quantum indicated can be mobilised in the foreseeable future. Additionally, the last set of measures announced by the RBI pertaining to limits on capital outflows from domestic residents and corporates, had briefly triggered fears of capital controls. While this was vehemently denied by authorities, a view that sustained since then was that policymakers are truly scrapping the bottom of the barrel in their defence of the rupee. These led to a virtual breakdown in debt markets with 10 year bond yields soaring to levels last seen in 2008. The RBI responded to bond market developments by allowing banks to transfer securities to held to maturity (HTM) books at previous prices, while also committing to do OMO purchases of bonds in order to prevent sharp rise in long end yields. Alongside, the RBI made some observations and statements of intent as follows:
 
1. Immediate objective of raising short term rates has ‘substantially been achieved’. Going forward, the RBI will calibrate issuance of cash management bills (CMBs) including scaling them down as may be necessary, to keep money market rates around MSF rate until volatility on rupee eases.
 
2. While it is important to address risks to macro-economic stability from external sector imbalances, it is also important to ensure that liquidity tightening does not harden long term yields sharply and adversely impact flow of credit to productive sectors.
 
These provided some measure of relief to bond markets. However, most of these proved temporary as the rupee lost any semblance of an anchor towards the last part of the month, depreciating 7% to 68.8 levels in 3 trading sessions. Apart from the usual India pessimism, a proximate reason for this was fears of a large spike in oil prices triggered by a possible strike by US on Syria. The RBI stepped up for the currency market as well announcing forex swap facility to take care of the entire daily dollar requirements of public oil market companies (OMCs). This is estimated at approximately INR 8 billion per month. Subsequently, the rupee saw some respite rising to below 67 levels to the dollar. The fears around US attacking Syria had also been partly pushed back by the month end.
 
Going Forward
 
Recent overshoots in both bond yields and the currency have made market participants quite watchful in the near term. This is despite the RBI explicitly expressing discomfort with rising long end bond yields and conducting OMOs on a regular basis. However, should the rupee continue to stabilize, the bond market will find more confidence. Currency stability in turn requires continued measures from the government and the RBI. A substantial diesel price hike post conclusion of Parliament session early September along with the oil minister slated to unveil a plan to save USD 25 billion on petroleum imports are 2 things that will be keenly looked out for. Furthermore, market would expect the RBI to continue to be active in the forex market in order to prevent spikes like the one seen in late August. Finally, at some juncture measures to further boost capital flows (NRI bonds for instance) may need to be deployed as well. The 2 event triggers will be 1) the Fed policy for September where many expect taper to start and 2) The maiden policy of the new RBI governor after the Fed policy.
 
While these triggers may keep near term market volatility, we believe bond valuations today are fairly rewarding investors given the overall macro-economic picture. This includes a sharply worsening growth environment and weak credit demand as bullish triggers and current and fiscal account deficits as bearish triggers.

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IDFC Mutual Fund

Last month was exceptionally challenging for India as a country. INR defied gravity and touched an all time low of 68.80 before closing at 65.70 (most of the recovery in last two days) which is a depreciation of 8.8% for the month of August. Equity market reacted sharply to the macro and external sector developments with the broader indices across market capitalizations closing in the red with nifty being down 4.7%, Mid cap and Small cap falling 4.1% and 2.3%, respectively.
 
Low GDP growth with a tight liquidity environment has started hurting both the pricing power and the cost structure of the corporate sector in India. Across sectors the underlying growth/ margin drivers are getting tested. An inverted yield curve does not augur well for the interest margins of the banking and financial services space, rising import cost because of INR deprecation in an environment of low growth hurts the consumer part of the economy, severe raw material and regulatory hurdles have anyways throttled growth for the investment part of the universe. While the tight liquidity stance may be reversed in the short to medium term as and when the INR stabilizes but from a growth perspective it will be a long time before we can reap any benefit as the social underpinning of the current political regime has starved the country of fixed capital formation. The consumer, banking and capital goods indices reflected the pain being down by 6.6%, 9.9% and 13.9% respectively.
 
Today within India market interest is getting polarized towards the export/outsourcing part of the economy which is the clear beneficiary of pickup in growth in the western world and current INR depreciation. The IT Index was the best performing index for the month generating a return of 7.6%.
 
The case for DM v/s EM trade gets strengthened as stability and growth returns to the developed world with US GDP growth at 2.5% v/s expectation of 2.2% and European PMI’s picking up too. Incremental data points and commentary from China also give some sense of stability. Fallout out of this has been the surprise performance of the metals pack (especially companies which have some linkage to global growth) after a very long time. The metals index closed positive 13.1%.
 
Foreign investor today is jittery and wary of the underlying volatility in the Indian markets with the volatility Index is currently at 27.81 above the long term average of 26.84. While they have been selling Indian equities, the net outflow hasn’t been very large so far. Even with a net outflow of US$902m in August YTD flows stand at US$11.6bn.
 
On the Macro front, WPI inflation at 5.8% in Jul’13 came in as a negative surprise. Inflation rose sharply on the back of increase in fuel prices and surging food prices. Food price inflation has hardened substantially in the last few months with July’13 reading coming in at 11.9%. This inflation print does not yet factor in increase in prices due to INR depreciation. The decision to increase diesel prices is pending due to the ongoing monsoon session. We continue to believe higher fuel prices and increased under-recovery will continue to put pressure both on inflation and subsidy thereby impacting both the government finances and disposable income for the household.
 
GDP growth of 4.4% for the April to June 2013 quarter is the quantification of the underlying deterioration. We collectively need to get our act together to restore the lost faith in the economy.
 
Going forward
 
In summary the valuations are good; the macro environment continues to deteriorate. India’s twin deficits have come to haunt it and it is all manifesting itself in the currency. Foreign investors are no longer willing to fund the country’s social leanings. While the debate in a country with 1.2bn people, mostly poor, is towards getting the lower end of the population to participate in the direction of the economy, somewhere along the way our policy makers forgot to create the capital for it.
 
There is something we have never seen before – 10% depreciation in the currency in one quarter, under recovery of Diesel @Rs15 per liter the highest we have ever seen. Subsidies have hit an all time high as a percentage of GDP and we are heading into an election in year 2014.
 
While as bad as it may sound, asset prices are representing the underlying macro environment. As an investor and manager of India Assets, we like the pricing – but not sure as to where the upside would come from. For the latter to happen there needs to be a huge shift in the mindset of the political system.

Tag:

Suyash Choudhary

A fistful of dollars

By: Punam Sharma

Bond markets have been in a turmoil ever since mid-July, when the RBI mounted an aggressive interest rate defense to the depreciating rupee. The purpose of these measures was to essentially increase carry cost of holding rupees. This in turn was expected to discourage speculators and incentivize holding rupee assets and thereby stabilize the rupee. As we have noted earlier, these measures had to be considered as step 1 of a 2 step process. While speculation may have been partly the reason for rupee depreciation, a larger reason was simply the lack of availability of dollars given volatility of portfolio flows on account of Fed tapering expectation and a high run-rate of dollar demand given our large current account deficit. Hence, step 2 had to involve credible measures to increase dollar supplies to the market. It is with respect to this step 2 that the first set of measures announced fell fully flat. It may be recalled that finance minister Chidambram had earlier announced a host of dollar flow measures totaling to USD 11 billion. To our mind, a significant part of the rupee’s outlier weakness subsequently was attributable to market not having found these measures credible.
 
It is against this backdrop that RBI announced its last set of measures. It first offered to meet the full dollar requirements of oil market companies (OMCs) under a swap facility. This has taken out approximately USD 300 – 400 million of daily demand for dollars from the market, thereby weakening the demand side for dollars. Next the central bank moved in with credible dollar flow enhancing measures. The 2 main ones are as follows:
 
1. It has offered a special concessional window to banks to hedge dollar risk on fresh deposits garnered under FCNR (B) deposits for a minimum period of 3 years. This dollar swap will be available at a fixed rate of 3.5%. This is a good 350 – 400 bps lower than market levels for the hedge. Additionally, under an earlier guideline the RBI had exempted maintenance of CRR and SLR on such new FCNR deposits and also allowed banks not to maintain priority sector lending on advances made against such new deposits. In total, these measures have substantially brought down the ‘landed’ cost in rupee terms of raising FCNR deposits. Thus far the incentive to raise these deposits was minimal since the landed cost was prohibitive and it was much cheaper to raise rupee deposits locally. However, with these new guidelines these deposits may become the cheaper option. Foreign banks are expected to bring in substantial flows via this route as they can offer leverage to their off-shore NRI investors and thereby increase manifold the quantum invested under such deposits.
 
2. It has allowed banks to raise offshore debt to the extent of 100% of unencumbered tier 1 capital from 50% earlier. Additionally, it has offered to hedge dollar risk on these loans at a 100 bps discount to the market rate. Again this window is expected to garner good dollar flows from banks.
 
All told, the above 2 measures are expected to garner in excess of USD 10 billion over the next 2 months (the facilities have been provided till end November). When combined with absence of daily OMC dollar demand and some fillip from a better trade deficit, the demand versus supply scenario for the rupee has been substantially improved at least for the next few months. This is showing already in a sharp appreciation in the rupee since the measures were announced.
 
While the above provides a timely backstop to the rupee (timely because we are just heading into the Fed’s meeting where the infamous ‘taper’ is expected to begin), the medium term outlook will depend largely on what measures the government takes towards mending our structural deficits. The current account deficit (CAD) has been the one under most scrutiny lately. A lot has been done here already and media reports suggest that more measures to restrict non-essential imports may be on the anvil. Broadly, we don’t have much disagreement with the finance minister’s commitment that he will contain CAD at USD 70 billion this year. However, the challenge has shifted to ensuring capital flows continue, since these can fall short of even a shrinking CAD. It is here that the government has a large role to play. Apart from CAD, the other reasons not to buy India are a persistent fiscal deficit and a severely supply constrained growth environment. For all the finance minister’s comments on 4.8% fiscal deficit being a red line, there’s very little action here so far for markets to get convinced. The dilly-dally on petroleum products’ price hike is not helping matters at all. Now that RBI has genuinely bought us some time on the currency front, the government has to truly step up and positively surprise with action on fiscal and supply deficits. Failure to do so may make markets relive all the recent pain at some point in the future.

 
 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Suyash Choudhary

The RBI in consultation with the government has cut the size of this week’s auction by INR 5,000 crores to INR 10,000 crores. It has cut the entire supply of the ‘long’ segment from this auction (defined as 2032 and above). The reason cited is ‘in view of prevailing market conditions’. It may be recalled that the RBI had started doing OMOs in order to cap rise in long term bond yields. However, this exercise was not having the full desired effect since the market was still showing reluctance to bid in auctions despite tendering OMOs at much lower yields to the RBI. As an example, in the last week the RBI accepted 2032 bonds under OMO all the way till 9.08%. However, the equivalent 2032 bond in the auction on the same day was bid at 9.34% by the market. Hence, the objective of capping long bond yields wasn’t getting fully met.
 
Reducing the auction supply itself will have a much greater impact on reducing long bond yields. After this week, and assuming the cancelled amount of INR 5,000 crores for this week doesn’t get adjusted next week, the next auction supply is due in the week of 20th September (also the week of Raghuram Rajan’s maiden RBI policy). Alongside, there is a bond maturity of INR 46,000 crores due today. Hence, the net supply equation is extremely favorable for bonds and may allow market to look through some of the geo-political uncertainties in the near term.
 
On a separate note, the auction reduction reaffirms RBI’s commitment to curb impact of its hiking short term rates at the long end of the curve. It may be recalled that while announcing its last set of measures of allowing HTM transfer for banks and doing OMOs, the central bank had made a strong statement of intent. It had said that while it is important to address risks to macro-economic stability from external sector imbalances, it is also important to ensure that liquidity tightening does not harden long term yields sharply and adversely impact flow of credit to productive sectors.
 
This reaffirmation along with a 4% growth handle precluding any further negative monetary action should provide a lot of comfort to bond investors. We reiterate our view that given the balance of macro-economic risks, the bond curve currently is sufficiently rewarding medium term investors. Given this, we are happy to reiterate our long duration stance.
 
 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Suyash Choudhary

India’s June quarter GDP printed a below-consensus 4.4% growth. This represented the lowest growth since March 2009; the quarter immediately succeeding the Lehman crisis. The break-up of the print was even more worrying since the only 2 highlights were higher agricultural growth (2.7% y-o-y, the highest in 4 quarters) and government spending (9.4% y-o-y, the highest since 2009). Non-agricultural private sector growth has virtually fallen off a cliff printing just 3.8% growth, again the lowest since March 2009. Also, as can be seen in the chart below, this is for the first time in recent history where private sector GDP growth has slipped below the overall GDP growth.
 
 

 

Source: CEIC and IDFC MF

 
 
Near term growth outlook:
 
Agriculture growth is possibly a sustained positive trigger for the year going forward, even though we owe it strictly to providence and nothing that policy makers have engineered. With respect to government spending, even though heightened spending as aided growth thus far, the government will have to focus on reducing spending going forward if it is serious about meeting its fiscal deficit targets for the year. Indeed, latest data shows that the government had notched up 63% of the total fiscal deficit target within the first 4 months of the fiscal itself. Also, recent media reports suggest that cuts in plan expenditure may come back on the table, although the quantum of reduction may be lower than that implemented last year. Finally, the RBI’s liquidity squeeze has only been in place since mid-July and the bulk of aggregate demand hit from this source will only show from the current quarter onwards. These imply that it is hard to expect any sort of a rebound in growth at least for the foreseeable future. Reflecting the overall gloom, we have seen sharp GDP downgrades from most private sector economists over the past few days : from 5 – 5.5% to 4 – 4.5%. Indeed, just released manufacturing PMI for August shows a reading of below 50 (which indicates contracting manufacturing). This is the lowest reading since March 2009 (yet again). Importantly, the PMI data indicates that price pressures have come off; presumably with demand destruction compensating for the upward pressure from currency depreciation.
 
 
Implications for policy:
 
Quite predictably, when last asked that RBI’s interest rate defense against the currency doesn’t seem to be working, the out-going governor Subbarao retorted that one doesn’t know the counterfactual: that is, one doesn’t know what would have happened to the currency had the RBI not mounted its interest rate defense. That is a fair point, and one that has been used by Subbarao earlier in the context of inflation as well. However, in the present case given that India hasn’t behaved very differently from other similar emerging market peers during this period, the simple question really is whether a non-quantifiable potentially marginal benefit justifies a very visible substantial damage being incurred by the domestic system. Indeed, between July 16th and today (the period since RBI’s measures have been in place) the rupee is the worst performing currency amongst its emerging market peers. In fact apart from USD 2 billion odd of debt outflow during this period, India has also lost USD 1 billion of equities. While admittedly market sometimes tends to ascribe simplistic explanations, one reason we have heard given is the concern with respect to growth given this period of liquidity squeeze in an already weak environment.
 
In our view, it will be difficult for RBI to disregard the growth mandate even if the number one priority remains currency. This is because in a global context, weak growth for emerging nations like India will be construed as a credit trigger. This in turn will have further implications for the currency. While we have consistently argued for limited applicability of interest rate cuts in supporting growth given the nature of this cycle, it is also true that RBI policy cannot afford to squeeze the environment for a prolonged period of time given the rapidly weakening growth impulses. Therefore, we reiterate a view we have expressed since these measures came into being: while it is difficult to predict when the RBI unwinds the current set of measure, we don’t believe that these measures indicate any sort of a reversal to the central bank’s policy cycle.
 
The other more critical player in this is obviously the government. While they continue to make the right noises with respect to our fiscal and current account deficits, markets will now like to see them swallow some bitter pills. The key near term action will have to pertain to reigning in what threatens to be a run-away oil subsidy bill. Talks abound of a large one time diesel price hike (proposals for some hikes in kerosene and LPG are also apparently doing the rounds). After this and over the next few months, the government will also have to seriously start looking at fresh measures to compress expenditure. Barring action on these, any talk of 4.8% fiscal deficit target being a ‘red-line’ will sound too weak to merit much attention.
 
 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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