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Investment Insights

Suyash Choudhary

The RBI delivered to consensus expectation today by doing the following:
 
1. Hike repo rate by 25 bps to 7.75%
2. Cut MSF rate by 25 bps to 8.75%
3. Hike cap on term repo borrowing of banks by 0.25% of net demand and time liabilities (NDTL)
 
With the measures taken today, the process of realigning the LAF corridor is complete with MSF rate being 100 bps higher than the repo rate; as was the case earlier. Furthermore, the RBI has continued forward with its objective of developing the term repo market by incentivizing continued usage of this window; at least till liquidity deficit continues to be in the range it is at today. To recap, banks have 3 liquidity windows (amounting to 0.5% of NDTL each) available to them before tapping into the MSF penalty rate. These are repo, export credit refinance, and term repo. All combined these amount to INR 116,000 crores of liquidity. Any excess deficit will need to be funded via the MSF window.
 
In terms of stance, the policy is in continuation of what we know of the RBI’s evolving stance under the new Governor (Please refer our note “Of inflation, expectations, and targeting”, dated 15th October for details). In summary, he is concerned about and willing to act to anchor inflation. At the same time there is a clear recognition that this has to be done in the context of weak growth. The RBI has given forward projections for WPI and CPI in the policy (the latter for the first time). The broad assessment is of WPI to remain higher than current levels for rest of year while CPI, despite food inflation softening, will be around or higher than 9% of rest of year. The forward guidance on monetary policy seems entirely neutral and data dependent with the central bank stating that it will ‘closely monitor inflation risk while being mindful of the evolving growth dynamics’.
 
View Forward
 
While the new Governor’s bias is to anchor inflation, there is clear emphasis that it will be done in the context of the weak growth environment. To that extent, his stance hereon looks completely neutral to us. The next prints on inflation are likely to be higher given adverse base effect and still enduring pass through of higher vegetable prices and that of currency depreciation. However, once the benign effect of better agricultural output shows on primary articles’ prices and the currency depreciation pass through is complete, the momentum in inflation prints may begin to come off. Additionally, the RBI currently estimates full year growth at 5% which seems too optimistic especially if the government will slowdown expenditure in days ahead in order to curb fiscal deficit. It is true that Q3 GDP numbers will not be available in time for the RBI’s next policy review in December (RBI expects GDP growth to pick up from Q3). However, if monthly growth indicators continue to be subdued and government expenditure cuts pick up pace, a further rate hike in December may become a question mark. If market expectations take that direction then term spreads on the yield curve may start to shrink further.
 
The other uncertainty is with respect to the RBI’s liquidity management stance, and hence the outlook for OMOs. In the previous regime, the anchor for liquidity was 1% NDTL for banks. However, the new Governor doesn’t seem to be guided by any sort of a quantitative benchmark on liquidity. Liquidity deficit currently is at 1.5% of NDTL and is expected to go up further as currency leakage continues over busy season and with impending elections. Market will look for more guidance, either in words or actions, on the central bank’s liquidity management stance in the days ahead. If OMOs are resumed to plug incremental liquidity deficit, they may also serve to reduce current term spreads on the yield curve.
 
Overall market volatility has been compressing over the past few days as the global environment has (at least temporarily) become more favorable and concerns with respect to our current account deficit have abated. With somewhat more insights into RBI’s thinking, today’s policy should serve to further compress volatility as the market may become biased to trade a range for some time. In the near term, concerns with respect to the next inflation readings and a large supply calendar for November may keep sentiment relatively cautious. However, as the benign effects on food inflation from a better harvest and (hopefully) government’s efforts at fiscal consolidation start to show, this should begin to rub off on market sentiment as well.
 
For investors, we continue to advise matching risk appetite and investment horizon to fund selection. Also, as a general rule, investment horizons amidst heightened market uncertainties should be longer than what they otherwise would be under normal markets.
 
 

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

Financial markets got a severe jolt with both the WPI and CPI prints jumping substantially to way above consensus levels. This has led bonds to lose the bullish tailwind that had been developing lately on the back of an earlier than expected second round MSF cut from RBI and generalized rupee strength. Furthermore, basis Raghuram Rajan’s recent interviews markets expectations had started to stabilize with respect to future trajectory of repo rate hikes. With these prints, sections of the market are again beginning to fear if more than one 25 bps hike may be forthcoming.

While it is always difficult to predict the thinking and action of what is essentially one person (remember RBI as an institution wanted to cut rates in its first quarter policy review), we discuss here some of the issues that we think are relevant in forming future monetary policy expectations from the RBI.

The difference between inflation targeting and inflation anchoring

Since he has taken over, the new Governor has been emphasizing the need to control inflation. This is also positioned as an internal determinant of the value of the rupee; securing the stability of which is a mandate given to the central bank in the RBI Act. He has also constituted a committee under deputy Governor Urjit Patel, one of whose terms of reference is to recommend an appropriate nominal anchor for the conduct of monetary policy. These have led to market fears that Rajan will be an inflation hawk. Some analysts have also sharply revised higher their expectation of the repo rate trajectory in line with this view on the new Governor. Ironically, this is even as growth forecasts have been cut across the board.

In our view, this assessment has to take into account the difference between inflation targeting and inflation anchoring. An inflation targeting policy approach would respond to inflation alone irrespective of other macro-economic variables like growth or external account. Thus in the current context with both CPI and WPI outside the realm of comfort the RBI, were it targeting inflation, would be fully justified in embarking upon a series of rate hikes even as growth impulses remained as weak as they are. However and again basis recent words and actions from Rajan, it does not appear to us that RBI policy has turned towards inflation targeting in the sense as defined here. Instead the endeavor seems to be to reestablish inflation credibility and to communicate monetary policy in terms of an inflation anchor. This does not mean that the central bank will be oblivious to other variables like growth. Instead in our view it means that monetary policy will be communicated in context of a single variable, inflation. Thus, for instance, the RBI will take into account the weak growth but assess it in terms of the impact it will have on inflation.

Sample the assessment made on this variable in Rajan’s maiden monetary policy. In the policy ,the RBI saw 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). More explicitly, it recognized a trade-off between need to anchor inflation and inflation expectations against addressing the fragile state of the industrial sector and urban demand. Indeed, in recent interviews Rajan has explicitly said that the fight against inflation will keep in mind the state of the economy: Quoting his exact words from one of the interviews: “ If the economy is very weak, those disinflationary impulses will help you in the fight against inflation. So you calibrate the interest rate keeping in mind the state of the economy and the level of inflation”.

Inflation anchoring may be desirable given the confusing multiplicity of objectives that seemed to be the case with the last RBI regime. This will help clarify the communication of monetary policy and also ultimately serve to anchor inflationary expectations.

How can the RBI target inflation in the current context?

Let?s for a moment assume that the RBI wants to target inflation. We have used WPI for analysis below.

 

 

Source: CEIC & Bloomberg

 
The first graphs above tracks headline WPI (red line) versus WPI excluding fruits and vegetables (blue line). As can be seen, inflation reversed its falling trajectory after May this year. What is also evident is that this was almost entirely attributable to fruits and vegetables. Thus while WPI excluding fruits and vegetables kept falling, the headline print started to climb again. The same is illustrated in the second graph where the percentage contribution of fruits and vegetables to overall WPI inflation is tracked. It can be seen that the contribution of fruits and vegetables to overall inflation has been steadily rising after May and now stands at its highest in more than 3 years.

Given this context, and assuming a reluctance to wait for the unnatural contribution of this element to subside, an inflation targeting central bank would have to necessarily create a larger disinflation in the rest of the economy in order to influence the headline rate. However, this is fraught with a number of risks. An exaggerated demand compression engineered for non-agriculture sector may trigger a commercial disincentive to produce and overtime cause a re-allocation of resources away from the sector. Further, it would further weaken the already weak employment scenario with consequent welfare effects. Alternatively, if there is a demand versus supply mismatch in the primary sector then theoretically the RBI could move to target demand for food. However, this again has massive welfare implications and it is difficult for the central bank to entertain even the thought of this. Given these challenges it will be extremely difficult for the RBI to target inflation at least as it stands today, even if it were to decide to become an inflation targeting bank.

Conclusions

The analysis above is aimed at trying to determine what the future reaction function could be of the new RBI with respect to the repo rate. To us it is quite clear that Rajan does not intend a series of rate hikes even if he adopts an inflation anchor (as opposed to inflation targeting). His words and actions thus far seem to suggest the same. We have already discussed above takeaways from his recent media interviews. In terms of action, since the last policy review the RBI has done a series of things that demonstrate sensitivity to growth. One, it has assured market of adequate liquidity for credit demand and in the process done OMOs to stop yields from hardening. Two, the Governor has endorsed a selective demand stimulus from the finance minister (via extra capital infusion to banks to enable them to lend at lower rates to select sectors like two wheelers, consumer durables, etc). Three, it has moved earlier than expected to cut MSF rate a second time even though there is an event uncertainty currently with respect to the US debt ceiling debate and oil demand for dollars is still being serviced directly by the RBI.

The current uncertainty is imparting a large term premium to the yield curve. However, as market expectations of future policy action stabilize and nationalized banks come back with full participation to the market presumably once the repo rate is fully restored as overnight rate (already their participation has been better since the last MSF rate cut), we would expect term premium to reduce. The process will be further helped by second half OMOs which will be necessary once the RBI reverts to its earlier liquidity framework.

 
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 a somewhat surprise move, the RBI has further relaxed the exceptional liquidity measures undertaken mid – July in defense of currency. After having cut MSF rate by 75 bps to 9.5% in the September policy, the central bank has further cut this rate by 50 bps to 9%. Furthermore, it has decided to provide additional liquidity via term repos of 7 and 14 days for an amount equal to 0.25% of net demand and time liabilities (NDTL) of banks. The term repos will be through variable rate auctions on every Friday beginning 11th October.
 
The announcement comes as a surprise to the market as participants would have expected more time to lapse before the next round of the ‘calibrated’ unwind. Specifically, oil marketing companies’ dollar demand is still being serviced directly by the RBI. However, the move shows increased confidence from the RBI that the reduced volatility in the currency will sustain. Additionally, it may also signal an urgency to reduce the liquidity squeeze in a speedily deteriorating growth environment and especially ahead of busy season credit demand.
 
The term repo facility will allow banks to borrow additional amounts at rates below the prevailing MSF rate. It may be recalled that the central bank had capped banks’ borrowing under repo at 0.5% NDTL of each bank. The term repo is presumably available for a 0.25% of NDTL amount extra (approximately INR 20,000 crores). Additionally, the facility is not capped at 0.25% of NDTL of each bank but for the banking system as a whole. This may allow banks who need the funds more to tap into higher amounts. Since the facility is available at a variable rate, so long as banks are still borrowing under MSF, the term repo may get bid at rates closer to the MSF rate. However, on margin this will still make fund availability cheaper than borrowing at MSF rate.
 
Bonds should take this cue very positively, especially with the surprise element thrown into the move. However, anxiety on future repo rate hikes may remain. While we cannot rule out some incremental normalization in the repo rate, we reiterate our view that we don’t think this is the start of a sustained repo rate hike cycle (please refer “Discounted credit to auto and durables? An assessment” dated 4th October for details on our logic for that view). Given this, and barring fiscal risks, we remain positive on the interest rate environment.
 
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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admin

The fund is invested 93% at the end of September of 2013. The fund is fairly diversified across 63 companies. The objective of the investment stance was to put together a portfolio of companies that would come through the downturn of this economic cycle. We were keen to allocate capital to companies that have the ability to generate cash flows and promoters that are equally interested in their companies. Promoters increasing their holdings and companies that have no or extremely low debt on their books; all of these are now a part of this portfolio.
 
The weighted average PE multiple of the portfolio is 12x; average debt: equity of 0.30:1 (ex financials) and cash as a percentage of Enterprise Value (EV = Market + Debt) in most cases at 12%.
 
The macro environment remains challenging with the capex cycle some distance away. In the near term consumption should hold up with the elections around the corner and the government’s social sector spending still holding up. A huge devaluation of the Rupee makes the business of exports more competitive. While there is no significant one trend that is emerging under the current context relying on company execution rather than macros make is a more viable strategy to start with. First we get into a protection mode – The larger holdings represent a group of companies that have little stress on their books. Cash @ 18%~ of book dominates the top 10 holdings (ex financials) of the portfolio. This part of the portfolio forms the structure around which we have picked companies to form the remainder part of the portfolio. For us in this volatile environment, survival and consolidation is a key metric. Execution risk is secondary.
 
The initiative through the next couple of lines is to walk you through the thought process of construction of this portfolio. Consolidating Industries, Underleveraged plays and operating leverage are a stance that we will stick with into the next couple of quarters. This adequately is represented by some of our larger holdings.
We have a portfolio of 63 companies at present in the portfolio. Most of them highlight the characteristics of the top ten holdings. Some of these would get changed in the course of the next few months should the opportunity arise. With the portfolio PE at 12.5x the downsides are captured (we are not saying it can’t go lower). The solvencies of the companies are pretty much established as none of the companies in question are geared (0.30:1; D: E) they will survive and grow into the next cycle. We have not touched on the subject of growth here since we believe that this is a consolidating cycle. But it is imperative that a large part of this portfolio has enough spare capacity and operating leverage to build the future. Add a cash intensive balance sheet; they should lead the next cycle forward.
 
Which takes us back to expectations
 
In our last communication we mentioned
 
“It is one big macro event. The capacities are there – the policies are not (the latter especially is not an easy thing to fix in India) especially going into the elections.
 
The asset class is almost in a low single digit to a negative return territory since early 2008. Unusual times, but then if we step into the 90’s we can’t really say things were different. In fact the macros today are more challenging. The economy is bigger and the problems larger. It is from challenging times like these that smaller opportunities spring and all good things start small.
 
There is nothing broad based that can lead the environment. It’s picking up the survivors, the ones that are consolidating. It’s almost like starting from scratch. It promises to be an exciting and a longer lasting cycle when it commences. In the last ten years – India has not thrown up any industrialist of any stature. It was easy liquidity that drove balance sheet creations. This time entrepreneurs do not have that luxury and their business models will and are already getting tested in these conditions. The new breed of survivors that emerges will be robust companies which fit our criterion of capital efficient companies with pricing power.
 
All this means that the broader indices can be listless for sometime reflecting the broader macro environment. The currency cannot depreciate at the current pace forever, but it may be still vulnerable. As the economy slows, foreign participation (FII flows) in equities will be cautious and vulnerable. Likewise Indian Investors too will tread with caution as the bond markets offer lucrative fixed return products. This doesn’t seem to be any runaway market and looks like it will follow a gradual process of build up. Election can be the only spoilsport and the outcome could decide the trajectory of the economy on either side. ”
 
And we are following it up with our preference which is displayed through OUR FUNDS…“Consolidators, Cash Flow positive businesses and companies with low debt are what we have stuck with for the last couple of years. These have worked well for us on a relative scale but have yet to deliver on an absolute basis for the last two year. We think from where the markets are today and the way economy is positioned; our investing style should work for an absolute return over the next two year. ”
 
Three Year Time Frame
 
The product was conceptualized with a three year framework and we have invested almost 96% (as on 7th Oct, 13) of the monies. Multiple events would shape the next couple of years. An upcoming election is the key. More importantly corporate have gone into a deep freeze in spends. No company is putting up capex and 2013 was the last year that balance sheet growth was through capital expenditure spends. This is good for capital efficiency and let demand catch up with the excessive capacities. Over the next two/ three years this consolidation should be good for pricing power as capacities get utilized. Till then accrual of cash on the books of Portfolio Company will act a stabilizing agent. A nominal growth in bottom line should be adequate for price appreciation of the underlying companies.
 
Portfolio
 

Comapny Industry %(NAV)
Hexaware Technologies Ltd. Software 3.29%
JM Finanacial Ltd Finance 2.88%
National Buildings Construction Corporation Ltd. Construction 2.78%
Persistent Systems Ltd Software 2.49%
Entertainment Network (India) Ltd. Media and Entertainment 2.34%
Motherson Sumi Systems Ltd. Auto Ancillaries 2.26%
MRF Ltd. Auto Ancillaries 2.24%
Polaris Financial Technology Ltd. Software 2.21%
Tilaknagar Industries Ltd. Consumer Non Durables 2.12%
Vardhman Textiles Ltd. Textiles – Cotton 2.10%

 
Top 10 holdings on 30th Sep, 2013
 
Source: Bloomberg
 
Data as on 30th Sep 2013
 
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. 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 internally, developed through analysis of IDFC Mutual Fund and market overview is developed from publicly accessible media. 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

As per media and a press release on the finance ministry’s website, the government has decided to augment banks’ capital infusion this year to beyond the INR 14,000 crores already budgeted. The additional amount of capital will be provided to banks to enable them to lend to borrowers in selected sectors such as two wheelers, consumer durables etc, at lower rates in order to stimulate demand. As per the ministry, “while this will bring relief to the consumers, especially the middle class, it is also expected to give a boost to capacity addition, employment and production”. Also as per the release, the decision is based on discussions between the finance minister and the RBI Governor Raghuram Rajan.
 
We must confess to being somewhat befuddled by this decision having the approval of the RBI governor. The RBI has only recently hiked the repo rate, showing discomfort with inflation. The repo rate channel is intended to signal higher cost of funds to banks and should eventually lead to a hike in deposit and lending rates once the transmission is complete. Of course, it may always be argued that on net the central bank had actually eased policy in its last review since along with a 25 bps repo rate hike, it had also cut MSF rate by 75 bps. However, as we have argued before (refer “RBI gives a signal for bonds; yet again”, dated 26th September), the repo rate has a large signaling effect and is considered a permanent directional indication. Whereas, the MSF hike had been positioned by policy makers as a temporary measure and hence many banks chose to not transmit it onwards.
 
Given the above, we are unable to understand the RBI?s endorsement of higher and lower cost of funds at the same time. The argument that the discounted credit window is being offered very selectively doesn?t help much. This is because irrespective of how selectively it is done, the net impact (however modest) is to add to aggregate demand. And for a central bank that presumably still sees the role for demand management in addressing inflationary concerns , endorsing a demand stimulus seems somewhat inconsistent.
 
In fact now that selectively targeted demand stimulus is being contemplated, why not try the absolute reverse? There can be no denying that India is in the grips of a generalized slowdown. This is now hurting current and prospective employment across a host of industries. PMI services data out just today shows no sign of turn in momentum for the sector that contributes the most to GDP. Given this, why not ease the repo rate and selectively tighten credit cost to particular sectors that the RBI believes are contributing to demand pressures?
 
Whatever the ideology it is increasingly clearer that the RBI doesn’t seem to intend a series of repo rate hikes, unlike outlier fears in the market. In recent comments, the new Governor has said that he is „neutral? on rates. Even in the last policy, while inflation concerns where apparent, the RBI had talked of inflationary (rupee depreciation and suppressed inflation) versus disinflationary (widening output gap and expected good harvest) forces. This seems a much more nuanced and data dependent view. Furthermore, since the policy the RBI has moved to address rise in bond yields as well as endorsed a selective demand stimulus. If the intent was to embark on a series of rate hikes, the central bank would not simultaneously move to kill its own transmission channel.
 
Over a period of time, as the market finds more comfort with the potential trajectory of repo rate, more stability should return to yields. Already, the benign effect of continued strength in rupee and comfort from RBI?s OMO are exerting a bullish bias to bonds. Over the medium term, most indicators barring the government?s fiscal math seem broadly supportive of a conducive interest rate environment.
 
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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IDFC Mutual Fund

Equity Outlook October 2013

By: Punam Sharma

WHAT WENT BY
The quarter gone by exhibited extreme news sensitivity. ( As an example the very news of Larry summers withdrawing his nomination led to US 10 year yield declining from its high of nearly 3%  and markets across emerging economies going up 1-2% the reverse of how they had behaved  at the mention of his nomination). As a meaningful economic recovery eludes the world at large we expect this kind of news flow based movements to take centre stage and keep markets across asset classes on tender hooks.
 
On the domestic front we saw India pushed to the corner with disruptive currency movements. INR depreciated to 69 levels before easing to the current 62.37 levels still 4.78 % down from 59.52 at the start of the quarter. The incremental news flow in the latter half of the quarter led to currency stabilizing at current levels. Delay in QE tapering, the appointment of Raguram Rajan as Indian central bank governor and a slew of measures (combination of measures aimed at destructing import demand and securing dollar flows and ensuring dollar liquidity) offered respite both for markets and the currency. The latest print on the current account came in at 21.8 bn usd (4.9 % of the GDP) is better than market expectations. The latest prints on the trade deficit (July-12 bn usd & August- 10 bn usd) too point to an improving CAD situation for India removing some pressure from the currency in the near term. However the extreme dependence on external flows to fund the current account will tend to make markets volatile till a more structural driver to bridge the gap is put into place. On a more optimistic note, hope is the high rates (repo rate hiked by 0.25%) can act as a precursor to incentivize savings thereby reducing dependence on external flows to fund investments easing pressure on the currency in a more structural manner.  Tendency to save than to spend may put pressure on spending, which does not augur well from a sales perspective for the corporate sector in India in the short term. However this will lead to a phase of consolidation for India Inc and ultimately usher the next wave of quality growth for the Indian economy.
 
Broad based growth is missing as far as the India economy is concerned and the situation on fiscal is stressed. The divergences in stock market performances have been stark. Market is getting polarized towards global growth and currency themes. The cyclical part of the economy with a high GDP growth multiplier is being abandoned despite offering attractive valuations. We believe as the scenario for easy liquidity fades investors will adopt a more selective approach towards building portfolio and the next couple of months will offer a slew of investable opportunities.
 

Sep-13 Aug-13 Jul-13
Difference between best and worst Index 11.67% 26.99% 31.17%
Best Index return (Index) 9.11% (Infra) 13.11% ( Metals) 17.38% (IT)
Worst Index Return (index) -2.56% (IT) -13.88% (Cap Goods) -13.79% ( Banks)
Reason Domestic vs Global, INR appreciation and partial reversal of liquidity tightening. Deferment of QE tapering Global Vs domestic driven by INR, Good macro data points from china and Europe Global vs Domestic driven by INR

 
GOING FORWARD
 
The underlying macro support for the Indian corporate sector is clearly missing. We have seen the slowdown trickle to the more resilient consumer oriented names too. The upcoming result season will have little to cheer either from a sales growth or margin perspective. This quarter had a disruptive move in the currency which would have impacted imported raw material cost and hence margins, the mark to market on the foreign currency debt and lastly tight liquidity will ensure subdued profitability. The good part is that now there is consensus that India is not a GDP growth story (Foreign brokerage economists estimate for FY14 range 3.7% to 4.20%) for some time though inherent levers for very strong GDP growth do exist in the economy over a slightly longer time horizon. We have the twin deficit issue which strains the currency as well the cost of doing business in India. This leads to deteriorating return ratios which are a precursor of consolidation and return of pricing power in any economy as these cut out the inefficiencies in the system.
 
Monsoons have been good and fairly well distributed. The first estimate of the khariff crop production came in at around 129.3 mn tons compared to 117 mn tons last year. The expectation for the Rabi crop is also good. Higher volume with stable realization will boost farmer incomes leading to resilience in the rural part of the economy. Feedback from corporate sector has been the growing growth divergence between rural and urban consumption growth. Aligning to companies with business interests aligned to the rural part of the economy is another opportunity which will unfold this year. Our portfolios stance across mandates it to align towards companies which would be the beneficiary of this trend across sectors either by virtue of their superior operating matrix supporting profitability and superior balance sheet helping them consolidate their position and be poised for growth going forward.
 
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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