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IDFC Mutual Fund

The scale of black money and unaccounted wealth in India has been much talked about although putting an exact quantum remains difficult. What is certain is that currency in circulation at ~12% (much higher than other economies) of GDP has been growing at a faster pace than nominal GDP growth over the last few years. The government has been committed to a path of implementing key reforms so as to reduce the quantum of parallel economy as well as cash based transacting. The latest announcement of the Prime Minister to withdraw the legal tender for Rs.500 and Rs.1000 notes from the midnight of November 8th is just another step towards achieving this goal. It has certainly shifted the economy into an uncertain phase.  While the medium and long term impacts of this move have been generally welcomed by most, the immediate and short term impact could be negative.

 

On the macro economic front, the impact is expected to be positive with contraction in money supply due to demonetization expected to be neutralized by a more liberal monetary policy with interest rate cuts being a key agenda item.  For a more detailed impact on the macro, refer our note ‘Move to Extinguish Currency Notes- Bond and Macro Implications Nov’16’.

 

On the micro front, the clarity, unlike the macro is far lesser.  While at an overall level, the impact will be most felt in distribution channels with myriad levels of cash transactions; to assess the impact of demonetization at a sector level, we propose an analysis derived by focusing on the supply chain from the producer to the consumer.

 

Broadly, three types of distribution channel emerge as illustrated below:

Type I:   Companies selling directly to dealer eg. Automobile/oil marketing companies

Type II:  Companies using a multi layered distribution channel where they supply either to own stores / exclusive distributors, wholesalers or retailers eg. Consumer durables, home improvement, ready-made garments

Type III:  Companies where wholesalers sell directly to retailers. Additionally, a multi layered distribution channel is used (excluding own stores) eg. Consumer staples, domestic pharmaceuticals

 
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Our belief is that the distribution channel directly controlled by the company i.e Type I will have least problems of bad debts / receivables in the short term. The other two segments will be impacted twofold (1) recovery of outstanding dues within the channel and (2) medium term impact on inventory management and sales, which may take a longer time to recover given the liquidity crunch. We believe that organized retail might benefit over the medium term and gain market share from unorganized retailers as incremental sales are likely to be driven through electronic modes of payment.
 
Two sectors, financial and real estate need special mention. With regard to the financial sector, strength of branch network is clearly evident. The collection at PSU Banks is several folds the collection of fresh deposits at big private sector banks like HDFC Bank and ICICI bank. In the Non-banking finance segment (NBFC), the race to grow loan book across various product segments such as Loan against property, loans to SMEs and micro SMEs, housing loans to self-employed will come under severe test in the coming quarters. We expect higher build-up of gross NPAs and modest credit off take in these segments over the next few quarters.
 
On real estate, the impact of this move is likely to be even more severe given the high element of cash transactions required; from buying land to sourcing regulatory approvals. Given that real estate has been the preferred investment destination for unaccounted wealth, the impact on the sector maybe long drawn. Self-occupied and self-constructed housing however may not be impacted. In order to counter the impact of demonetization, we expect an announcement from the Government on affordable housing.
 
Lastly, on consumer confidence, an erroneous thought has been built up over the last few days that consumption is dependent heavily if not entirely on black money. Just from a flow perspective black money in hand, was not necessarily being used for consumption, though it may have had a “wealth” effect. The emergence of middle class has been the most critical factor to spur consumption over the last decade; this move will continue going forward as well. We believe that consumer confidence is driven by certainty of income and confidence in the near to mid-term. In several international surveys Indian consumers have regularly been rated as amongst the most secure and bullish; it will be interesting to see whether that confidence sustains in the coming quarters. For a significant section of the consumers who are salaried and have mainly accounted wealth, it would be business as usual; for those with a significant share of unaccounted wealth, the coming quarters will be a period of adjustment. Sentiments to a large extent are driven by our surrounding environment, our media, unfortunately treats its independence as a license to stir hysteria. Hysterical media coverage may dampen the sentiment in the near term to some extent.
 
Among our key fund strategies, IDFC Premier Equity Fund continues to focus on the consumption theme, which may impact the performance in the near term however we are using the current volatility to realign our portfolios to add names which in our opinion are not only best in class in their categories across market cap segments but should also benefit from the revival as it unfolds. IDFC Sterling Equity Fund continues to focus on a rebound in investment cycle by participating in the mid and small cap segments. IDFC Classic Equity Fund continues to identify opportunities which combine quality with relative value focusing on the large cap segment. IDFC Imperial Equity Fund will utilize the current market opportunities to build a focused portfolio of companies. IDFC Infrastructure Fund retains its focus as a pure infrastructure fund with modest leverage as a key variable. IDFC Equity Fund focuses on large caps, a segment which offers more attractive valuations at current market levels.
 
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*Investors should consult their financial advisers if in doubt about whether the product is suitable for them.
 
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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Suyash Choudhary

As would be well known by now, the government has rendered defunct currency notes of 500 and 1000 denominations. There is a window provided to exchange outstanding notes with new notes and / or deposit them in respective bank accounts. To put this in perspective, the outstanding amount under these 2 note denominations is in excess of INR 14,00,000 crores; amounting to more than 80% of outstanding currency in circulation. In this note, we discuss the short term and medium term impacts of this move (basis certain assumptions), largely from a bond and macro perspective.

 

Short term impact

 
There are essentially 2 ways this can play out in the short term: One, large amounts of money gets converted to deposits with banks. This in turn will increase banks’ deposit bases and also increase tax collections for government as it levies taxes on this disclosure. Two, most of this money never comes back since the holder is afraid of getting prosecuted. In this case the RBI simply ‘extinguishes’ these bank notes as its liability once the window allowed for conversion of existing notes is over. Under the first case, banks’ deposit base rises immediately leading to lower deposit issuances and higher SLR appetite; whereas the government’ fiscal improves helping it achieve its spending targets and potentially even cut its borrowing program tactically. In the second case, the ‘windfall’ will rest with the RBI which may then get transferred to the government over a period of time. However, there are 2 caveats to this analysis: One, the tax loss on the back of economic activity stalling may potentially offset some of the gains for the government. Two, from a bond supply perspective, the anticipated reduction in government borrowing may get offset by RBI stopping OMOs from here on.

 

Medium term impact

 
Over the medium term, this measure is decidedly deflationary. The direct effect may get most visibly felt in real estate demand and hence prices; as well as in demand for items of discretionary consumption. On its own, there is even a likelihood that the incipient turn in wages starts to flatten out again; should this lead to a near term stall in construction activity. There may be second round rub-offs as well, for one with respect to fresh concerns on banking asset quality. These effects will decidedly be food for thought for a government that is committed to turning around economic growth. For that reason we think it extremely likely that, should there be indeed a net accretion to the government fiscal from the ‘parallel’ economy, the government will choose to spend it rather than save it. To put another way, it is unlikely that the government will seek extra fiscal compression (over and above the path indicated) on the back of this windfall. Rather, it would much prefer to accelerate spending to counter the drag on economic activity from this measure. Thus while we have flagged the possibility of some cut to the borrowing program, if at all this is likely to be extremely tactical since the economy cannot absorb a very large ramp up in spending in the near term. Over the medium term, we think the best way to visualize this is as a cash transfer from the parallel economy to the government who will then spend this money in accordance with the growth needs of the economy. It is to be reiterated, that the ‘cash bounty’ needs to be considered ex of the tax loss that the government will suffer as a result of economic activity slowdown.

 

From an RBI standpoint, this move does have the potential to open up room for further rate cuts (beyond the last 25 bps that most in the market were broadly looking for). This is because, so long as CPI is within the 4 – 5% band, the current RBI seems to be focusing on growth. This measure has potential to both reduce inflation and impact growth. Hence, from that standpoint it may be logical to expect more room from the RBI. Finally, global developments as always will impact the potential for domestic easing. However, given a relatively ‘tight’ local macro right now, the RBI may still be allowed some room to respond to a weaker growth-inflation scenario; unless the size of global disruption is very large.

 

Takeaways

 

The yield curve has been broadly steepening since August, quite in line with our expectation (please refer “Use Your Illusion: A Bond Market Update”, dated 16th August for details). However, a key aspect of the steepening lately has been expectation of limited rate cuts from the RBI. With this development, it is possible that market expectations become more aggressive in terms of future rate cuts. In line with this possibility, we have tactically increased duration in our bond and gilt funds; as we examine how the fall out of these measures pans out.

 

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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