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IDFC Mutual Fund

How has the Indian equity market changed in the last few years?

The last few years have been a fairly challenging period for India, characterised by lower industrial activity, increased subsidies and increased fiscal and operational deficits. The Indian equity market was probably not the best choice for investors before 2014. The main reason being the inability of the previous government to take any concrete actions to address these issues, especially at a time when emerging markets by themselves were off Institutional Investors’ radars. Some reversals may be in the works in 2014 – A new Government1 with an absolute majority is now in power. Lofty expectations for better governance and predictions of dynamic GDP growth and corporate earnings have pushed markets to an all-time high.

How do you see the markets now? Are things slowing down, or speeding up?

The markets always tend to follow big economic events. The new Government is focused on speeding up and implementing critical projects and policy changes. Nevertheless, contrary to the widespread expectations of revolutionary reforms, all changes have been incremental. This is what is to be expected from the new Government when implementing its plan for reviving the economy. Nothing radical – just make sure it works.

How do Modi and the stability that comes with this change in government affect the markets?

The new Government’s biggest change is its ability to make tough decisions because of its simple majority in the center. The markets have responded by hitting all-time highs. A lot still needs to be done to bolster the growth of the Indian economy. A fair estimate is that early 2016 should see some absolutely positive macroeconomic results. If that happens, equity markets should continue to be quite rewarding for investors.

What sectors will Modi and governmental policy change affect the most?

The Government is focusing on restarting all investments that stalled for either legislative or financial reasons. The emphasis on productivity and jump-starting the cash flow cycle for Indian industry would benefit companies across multiple sectors. The Government seems to be emphasising the competitiveness of Indian manufacturing internationally and at the same time, creating domestic demand. Agriculture and Infrastructure are two sectors that are likely to be bullish in the short term.

What are the key sectors for growth?

While Agriculture and Infrastructure will benefit from Government policies and funding, they would also be instrumental in driving employment opportunities for India’s large population. It will take some time for capacity in these sectors to wear themselves out, thus profitability could take some time to rear its head. India’s long-term growth opportunities remain the country’s dynamic demographics and strong consumer spending.

Will all sectors be affected positively? Are there any losers going forward?

If growth were to start up again, it would benefit almost everyone. The only caveat out here is the strength of the currency. India cannot afford to have a strong currency – but if there remains significant optimism for the country, it might be difficult to maintain a depreciating currency. This could impact a significant number of export-oriented companies.

What are the main roadblocks towards growth in the next year?

India should be able to grow by 5/5.5% in 2015. Over the last couple of years, the environment has become more and more driven by the central bank and therefore, any change in monetary policy may impact the economy on a short-term basis. Domestically, inflation, which posed a serious concern up until a few months back, has started to drop. This is the first time that the fall in inflation seems sustained and durable due to the proactive measures taken by the government and the fall in global commodity prices.

What other factors are affecting the Indian equity markets, besides the change in government?

Corporate earnings bottomed out in the 2014 fiscal year. This, paired with Industry’s record debt levels, pulled a 180 degree turn as early as March 2013. Earnings momentum should positively influence markets and this should move to higher, teen-level growth.

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 about the investment strategy /
theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is
already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions 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 recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. 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 th e 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. Neither 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 kept policy rates unchanged as was largely expected. Other significant changes made were as follows:

1. Reduced SLR by 0.5% to 21.5% of net demand and time liabilities (NDTL) effective February 7th.

2. Discontinued the export credit refinance (ECR) window entirely as a means of providing liquidity. However commitment to daily variable liquidity operations, over and above term repo operations, remain.

RBI’s macro-projections are as follows:

1. Real GDP forecast retained at 5.5% for current year (on old base) and pegged at 6.5% for next year

2. CPI inflation expected to meet RBI’s objective of 6% by January 2016. The accompanying ‘fan chart’ shows considerable uncertainties with even the 50% confidence interval ranging from 4.8% to 7.5%

3. Current account deficit (CAD) expected at 1.3% of GDP in current year

Besides, the RBI has made some changes / liberalizations to financial markets. Some of these are as follows:

1. Further increased limit under Liberalized Remittance Scheme (LRS) to USD 250,000 per person per year

2. Allowed reinvestment of coupon in government security investments by FPIs even though the current limit of USD 30 bn is getting fully utilized

3. Introduced minimum investment threshold of 3 years for FPI investment in corporate bonds in line with the regulation that exists for government bonds. However, there is no lock-in on such investments

4. Introduced new contracts in Interest Rate Future (IRF) for 5 – 7 years and 13 – 15 years besides the 10 year contract that currently exists

Interpretation and Takeaways

The RBI has pointedly kept the policy quite neutral today, taking forward its guidance from the inter-meeting cut in mid-January where it had said that further cuts would depend on new data that indicated 1> continued disinflation 2> quality of fiscal consolidation 3> supply side efforts to increase productive capacity as the economy recovered. On all 3 counts there is no new information yet with the RBI, even though general commentary on government intent seems to suggest that further progress will be forthcoming. On CPI specifically, the base year is slated to be updated with accompanying weight and basket modifications. While the general consensus is that this will cause very minor variations to the CPI reading, the RBI may be wanting to be surer on this count. Similarly, recent commitments from the finance minister as well as government already moving to shore up indirect taxes to fund infrastructure seem to indicate that the government will unveil a responsible, ‘high-quality’ budget at the end of the month. But again Rajan has chosen to wait and see how this pans out before making his next move. In our view, these are not indicative of an RBI being behind the curve. Rather, and as we have pointed out earlier, this indicates the extra level of commitment that this RBI has to stay the course once a decision is taken. Indeed, the Governor reiterated this very point in the post-policy media call saying that he will be reluctant to go back on a rate cut. This is very good news for investors since a stable monetary policy framework that throws up well considered rate cuts will keep rates and currency volatility much better behaved, as has been the case since mid of last year.

The Governor also seemed inclined to largely look through the massive upward revisions to GDP for last year post the updates done on Friday. Just as the Chief Economic Advisor pointed out earlier, the RBI seems to be paying more heed to concurrent indicators like non-oil imports, credit growth etc that seemed to indicate no meaningful uptake in economic activity last year. Thus these revisions are unlikely to change RBI’s view on future expected inflation. More information on the direction of growth will be forthcoming next week when CSO releases GDP assessment for the current year based on the new series.

Finally, the Governor has further narrowed his real rate ‘target’ band to 1.5 – 2% from 1.5 – 2.5% earlier. This was said matter-of-factly in the post policy media interactions but nevertheless holds valuable inputs insofar that the RBI’s policy framework currently essentially boils down to setting a real rate target over average CPI assessments for the future (for more on this please refer our earlier note “RBI Cuts Repo: Well begun but may not be half done”, dated 15th January). This also correlates well with a recent article from Rajan apparently referring to the negative welfare effects that may rise in developing countries like India if too rapid a pace of disinflation is pursued.

Way Forward

The policy today held very little new information for medium term investors. The key to forecast how many more rate cuts still rests with forecasting CPI inflation and the real rate target that RBI wants to set over inflation. As mentioned above, there is some additional clarity on the latter. On the former, the RBI is choosing to be cautious thus far and rightly so given that it is the policy maker and not a trader. Notwithstanding that, and assuming that dynamics of the new CPI series are not very different from the old one, we believe there is a good chance of average CPI falling towards 5% in the year ahead. If this happens, then the central bank’s framework will allow for meaningful cuts in the future.

In the very near term, market seems to be building in some uncertainty premium as the ‘front loaded’ rate cut expectations of some quarters seem to have been put to rest for now. Nevertheless, we believe that the budget at month-end is a more important trigger as it may serve to cement the structural view further. Subject to a friendly budget (our most likely scenario) we would expect RBI to move again either in March or at the April policy. Post that it may reserve further judgment till it assesses buildup of CPI in the April – June quarter. Bond investors with medium term views should do well so long as the structural theme remains intact; as seems the case till now.

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 about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions 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 recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. 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. Neither 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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