Macro Economic Review
May 2019 was an eagerly watched month within the country as well as outside the country as the results of general elections for the world’s largest democracy were to be announced. May 23rd saw the current government i.e. BJP party re-elected with a resounding majority of 303 seats (353 with partners) against a requirement of 272 seats to form the government. A large part of the rally in equity and bond markets had happened on 20th May, a day after the exit polls, which predicted resounding victory for BJP. Overall, the month saw the Sensex move up by 1.74%, 10-year G-sec yields down by 38 bps (and another 7 bps on 3rd June’19) and INR remaining stable last month. FPI flows turned positive post the election results with circa $1.6bn inflows across equity and debt markets.
Liquidity conditions within the banking system improved markedly post elections. The system deficit turned positive on back of FX inflows as well as government spending. RBI also announced an OMO of INR 15,000 crores for June’19. All these positive factors along with election results helped in lowering Gsec yields by circa 38 bps for the month. The 3 year PSU AAA Corporate bond yields also came down by ~20bps for the month.
Headline Consumer Price Index (CPI) for the month of April came in at 2.92% vs expectation of 2.99% and previous month at 2.86%. Primary contributor to the uptick was food inflation, which increased from 0.3% to 1.1% and was at its highest level over the last 9 months. Interestingly core inflation declined sharply from 5.1% to 4.5%, mostly due to drop in credit lending and slowdown across several sectors.
The sharp drop in core inflation along with IIP data of -0.1% are pointing towards growth slowdown. Manufacturing Purchasing Manager’s Index (PMI) of 51.8 and Services PMI of 51 were also near 7 month lows and pointing towards growth slow-down. Q1 GDP released on 30th May came in at 5.8%.
Oil prices for the month declined by 16.3% (between 30th April and 3rd June) as slower global demand was offset by geopolitical tensions between US and Iran and threats of tariff imposition by US.
Trade deficit widened in April 2019 to $15.33 bn vs $13.72 bn in April 2018 and $10.89 billion last month due to rise in crude oil imports coupled with muted growth in export. Exports inched up by 0.64 % y-o-y while imports rose by 4.48 %. Much of the rise in imports came from crude purchases, which rose by 9.26 %. Gold imports jumped by 54% to $3.97 billion in April driven primarily by strong demand during wedding season along with fall in prices, which prompted purchases.
FX reserves have climbed steadily over the past six months and, at US$418bn, are just 2% off alltime highs. Action by RBI (USD-INR swaps) and a rise in ECBs (approvals at multi-year high US$41bn run-rate) have helped foreign capital flows. With a stable government in place for the next five years and PM Modi’s commitment to keep macro stability intact, foreign capital flows may likely pick up.
On the global front, the on-going trade war between US, and China worsened slightly with US increasing tariffs on $200bn worth of Chinese goods causing emerging markets to sell-off. In addition US PMI data, home sales came in much weaker than expected. All these factors have caused US 10 year yields to rally 43 bps for the month and are now close to Sept 2017 lows. The downward move in global yield curves means now nearly $11 trillion worth of fixed income securities are yielding below zero, the most since 2016 as per Bloomberg.
Overall, the month has seen the election results driven rally in Indian equity and fixed income assets as the exisiting government has earned a resounding majority. A strong and stable government is expected to improve the investment climate and may likely cause foreign funds to pour in. Investors are expected to focus on the steps to be taken by the government to improve growth, RBI actions to improve liquidity and new budget proposals.
In contrast to global markets, India equities (Sensex +1.7%) ended strongly as the incumbent NDA alliance returned to power with a thumping majority with BJP, the single largest party, comfortably cruising past the simple majority. On the global front, US and China continued to issue statements on tariffs and counter-tariffs with markets swinging on new developments. GDP growth for FY19, however disappointed with both the annual and quarterly print coming weaker. In the semi-annual MSCI EM index rebalance, India was underweighted by ~34bps with 1 addition and 1 deletion coming into effect. In terms of economic indicators, barring consumer credit growth and cement volumes, most other indicators like auto sales, consumer durable production and air passenger growth continue to weaken sharply. The Q4FY19 earnings season was largely in-line, with Sales/EBITDA/profit growth for the Nifty companies coming in at 10.2%/6.1%/15.8% respectively with financials, domestic cyclicals and utilities driving earnings growth. RBI’s Monetary Policy Committee (MPC) is scheduled to meet for its bi-monthly policy review on 6th June and the general expectation is that of a 25bps rate cut.
In terms of sector level performances, the best performing sectors were BSE Capital Goods (+10.6%), BSE Realty (+9.6%), BSE Bankex (+5.8%) while the sectors which were major laggards were BSE Healthcare (-7.4%), BSE Metals (-6.6%) and BSE Infotech (-3.0%). Positive FII interest in India persisted though with inflows continued to moderate, while domestic investor interest returned after 3 successive months of outflows. Capital market activity in May too was lack-lustre as election uncertainty weighed down on primary markets.
Even as global markets are reflecting anxiety on US growth prospects, our global in-house view remains that of steady expansion with low inflation leading to lesser market volatility than in 2018. Since the last 6-8 months, we have been constructive on the Indian equity market from an opportunity standpoint; particularly in the mid and small cap segment given meaningful valuation corrections in several good quality businesses. While recent strong market performance does deter immediate further upsides, near term market performance will be guided by policy pronouncements of the new govt., upcoming Union Budget in early July and the progress of the monsoon season given its impact on India’s agriculture and food inflation.
Medium-term, our positive outlook is premised on improving macro factors - controlled inflation, stable commodity prices and currency, improving asset quality and credit growth cycle and likely moderation of interest rates. We think the modest improvement seen in corporate earnings last 2-3 quarters have now got the necessary conditions and building blocks to gather strength in coming quarters, which may be further aided by better consumer sentiment with the constitution of a strong and stable govt.
Besides, we regard global macro as stable and turning favourable for EMs in general versus 2018 as global interest rate cycle once again turns accommodative. This should be supportive of liquidity flows to emerging markets, which along with a strong govt. continuity will likely support valuations. We do not rule out time corrections to the market post recent sharp rally but also advise against excessive pessimism given earnings cycle once it improves this year, can well extend into the next couple of years.
Despite the strong political mandate, we prefer to refrain from our investment decisions being overly influenced by likely long-term reform measures being announced by the new govt. Some of the recent macro-headwinds require immediate policy attention and we would like to monitor improvements with respect to the same. We are also continuously reviewing solvency position of some of the large NBFC’s as a potential risk factor to our stable to improving earnings cycle view.
Our portfolio approach thus continues to remain balanced with bottom-up stock selection and sector selection playing an equal role. We believe evidence is emerging on strengthening a pro-cyclical stance and some portfolio shifts to capture a potential industrial/manufacturing recovery are being undertaken. Cyclicals with comfortable balance sheets and attractive valuations or companies with strong franchise value but presently facing growth headwinds do attract our attention.
Fixed Income Market
The bond yields have started to come off by 40-50bps over the month of May’19. The drop in bond yields has been due to the following reasons:
- OMO announcement by RBI
- Exit poll results in mid-May where it pointed to a majority for the ruling government
- The actual election results on 23rd May. A resounding win for the BJP government improving investor confidence
- Election results improving the sentiment of foreign investors leading to restart of foreign inflows
- Slowdown in domestic growth leading to expectations of higher doses of rate reduction and liquidity infusion from RBI
- Slowdown in global growth particularly in US and drop in US treasury yields by about 40bps
- Trade wars indicating further slowdown and drop in oil prices by about 15% indicating benign inflation in India in the near term
RBI has reduced the repo rate by 50bps in two tranches so far this calendar year. However, the bond yields had not moved lower post these two rate reductions mostly due to:
- uncertainty around general election results
- lack of liquidity in the market
- High supply of g-secs in the primary market
- Lack of demand from the foreign investors due to wait and watch stance before the general election results and
- Lack of clarity on monsoon rains
It appears that the demand from foreign investors to invest in the bonds of India (where real rates are over 400bps vs 150bps long period average) has started to move the wheel forward in terms of creating demand for Indian bonds. The domestic growth slowdown is also expected to nudge the MPC members to push through higher doses of rate reduction and infuse liquidity in order to address the deficit liquidity within the banking, NBFC and housing finance companies as well.
These anticipated actions of RBI is expected to work towards improving the surplus liquidity within the banking system and help in transmission of lower rates for the borrowers which in turn helps in capacity expansion and viability of projects. The drop in interest rates should also help in balancing the overall leverage across sectors and help in attracting equity capital as cost of savings and investments move lower.
The fears of an excessive borrowing calendar over FY20 and the uncertainty around attaining fiscal targets in a general election year had weighed on the market sentiment so far and now the investors look forward to the annual budget next month from the new FM.
We think slowing domestic real GDP growth is due to both slower global growth and slowing domestic consumption. On inflation front, we think headline CPI for CY20 should be comfortably well within 4% due to benign oil prices, drop in core inflation and soft food prices. Thus with slowing growth and high real interest rates, RBI will likely cut rates so as to push through lower rates into the economy. However, drop in repo rate do not always guarantee lower borrowing cost and hence we feel RBI may take additional actions to infuse liquidity so as to help lower the deposit rates of the banks and enabling them to price their loans cheaper.
As the market reposition to a strong political mandate and chances of steep repo rate reduction amidst widespread slowdown we urge investors to start selecting funds in alignment with their investment horizon and selectively longer depending on their individual risk appetite. Hence some additional duration over the investment horizon should work favorably as the risk return matrix is tilted towards lower rates.
The risks to this view emanate from higher government borrowing calendar of FY20. However, it may get neutralized through creation of higher demand for gilts and bonds by infusing liquidity into the system by RBI and or from higher demand from foreign investors amidst global slowdown.
Last Updated: 15th May 2019
Next Update On: 15th June 2019
Update Frequency: Once Every Month