Macro Economic Review
The Indian economy continues to maintain its steady performance. The headwinds of higher commodity and crude prices have waned off and fiscal situation appears to be in control.
The Consumer Price Inflation declined to 18-month low of 2.2% led by a fall in fuel (4.5% vs 7.2%) and transport (4.3% vs 6.1%) prices. The food price deflationary trend has moderated slightly but core inflation remains stable at 5.7%. The economy is witnessing an interesting trend where health inflation (9% YoY increase) and education inflation (8.4% YoY increase) is on the rise whereas the overall inflation number has come off remarkably, led by low food inflation number. We incrementally see the inflation numbers moving higher but is still in the comfort zone of the Reserve Bank of India. Considering the benign inflation levels, the MPC changed its policy stance and cut rates, based on economic backdrop and inflation data.
The current government presented its interim budget for FY2019 which had a populist undertone. The expenditure tilted towards agriculture / rural spend, driven by the PM-KISAN direct income support scheme while Revenue assumptions look a tad optimistic. The government estimates the FY20 fiscal deficit at 3.4% of GDP, which is a deviation from the 3.1% projected in the medium-term fiscal policy statement last year. It assumes revenue growth of 14% YoY on back of a 20.5% YoY growth in FY19 (revised estimate), whereas the current growth rate for FY19 YTD stands at 8% YoY growth. The government continues to rely on tax buoyancy, including from the GST, which we believe could be optimistic even if one considers implementation of E-way bill.
The Overall capex is projected to grow 6% YoY in FY20 (vs. 20% in FY19), reflecting deteriorating spending quality and a skew towards social welfare spending. We continue to maintain that capex will be the scapegoat of populistic policies and the multiplier effect will be lower on the overall economy. The rural package of per month allocation of Rs. 500, might lead to some improvement in consumption of staples or some level of upgrading of products in consumption basket but might not be enough to push demand for durable goods.
Meanwhile the Nov IIP dropped to a 17-month low of 0.5% after a big uptick of 8.5% for Oct 2018, which could be partly attributable to festive season stocking. The slowdown was broad-based, with contraction in intermediate goods, consumer goods and capital goods. The intermediate contracted by 4.5% YoY v/s 2% rise in Oct 18 largely driven by slowdown in metals. The capital goods contracted by 3.4% v/s 17% growth in October led by lower production of commercial vehicles while, consumer goods, decline in production was seen in both durable and non-durable goods. The latest IIP number confirms overall weakness seen in the consumption oriented sectors, along with other indicators like decline in passenger vehicle sales and slowdown in domestic air passenger traffic. The economy has witnessed first signs of lower consumption which was driving force behind the buoyant economy over the last decade and will be keenly observed going ahead.
The Dec. trade deficit narrowed further to 10-month low of USD 13.1bn on the back of fall in oil (3.1% YoY growth) and gold imports. On Financial YTD basis, the trade deficit of USD 143 bn appears much higher compared to Apr-Dec FY18 cumulative trade deficit of USD 119.6 bn as H1 was a much elevated number. The cumulative trade deficit for Q3 stands at USD 46.9 bn compared to USD 49.4 bn in Q2 FY19 which appears reasonable. We expect a lower trade deficit in Q4 FY19, led by the continued lagged downward adjustment in crude import bill.
India’s macro is reasonably placed, helped by lower commodity prices and a stable currency as we approach national elections. The political uncertainty and slowing economy are key things to watch out for, which could affect India going forward.
Indian equities stayed largely flat weighted down by uncertainty ahead of key events like the Union Budget and the upcoming national elections. The interim budget with a Vote-on-Account for FY20 is likely to be devoid of major changes if the traditions are maintained. Pre-election compulsions might force the announcement of a farm package which may put further pressure on the fiscal deficit. GST collections have jumped to Rs1 trillion in January this year from the Rs 947 billion collected in December last year. Economic indicators remain a mixed bag, Consumer credit growth remains healthy but auto sales have weakened sharply. In terms of sector level performances, the best performing sectors were BSE Infotech (+8.3%), BSE Consumer Durables (+2.7%), BSE Bankex (+1.2%) while the sectors which were major laggards were BSE Auto (-11.0%), BSE Cap goods (-8.0%) and BSE Metals (-7.4%).
Even as global markets are reflecting anxiety on US growth prospects, our in-house view remains that of steady expansion with low inflation leading to lesser market volatility than in 2018. US monetary policy is becoming less accommodative but the Fed is “not tightening”, only “normalising” policy, which can still support economic and business expansion for a long time. Recent correction in the US 10-yr yields seems to reflect this realisation. Back home, the quarterly result season is currently underway with few sectors like IT and banks having made a positive start while for the rest its been a mixed bag so far. The remaining portion of Q3 earnings will be a key monitorable. However key milestones such as normalisation of credit quality at key corporate banks and strength of consumer sentiment appear trending well and provide strength to the argument of a long-pending earnings recovery.
Indian markets will likely tread cautiously until its national elections in April-May 2019 even as more near-term attention turns to the Q3 corporate earnings season during Jan-Feb 2019. Recent improvement in macro factors such as oil and currency, should support overall market valuations and protect downside. Market may also be expecting a change in policy stance and possible rate cut as inflation trends continue to remain benign. Incrementally, we do turn constructive on the market from an opportunity standpoint; particularly in the mid and small cap segment given meaningful valuation corrections in several good quality businesses.
Our portfolio approach 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 Indian bond markets witnessed mixed performance in Jan 2019. Though yields had remained mostly stable, they were subject to some negative developments both in the domestic and overseas economies.The positives in the market over Jan (including early Feb) have been:
- Drop in headline inflation to a low of 2.19%
- OMO by RBI continued
- Pause in the rate hike path of Fed Reserve
- Softening of global bond yields
- Stability in the oil prices
- Surprise change in the monetary policy stance to ‘neutral’ from ‘calibrated tightening’
- Reduction in the repo rate by 25bps to 6.25%
The negatives in the market over Jan (including early Feb) were:
- Below trend GST collections
- Fears of fiscal slippage in India (FM announced a 0.06% slippage in the Budget announcement
- in Feb’19)
- Trade war posturing in the global arena
The 10 year benchmark yield was mostly trading between 7.40% and 7.65% depending on the flow of news. The slip in fiscal for FY19 and expansionary budget announcement for FY20 led to sell off in the bond market immediately after budget announcement.
While the demand for gilts remained positive due to OMO and stabilized the bond prices but the higher gross borrowing for next FY and the extra Rs 36,000 crore borrowing for FY19 dampened the market sentiment. Overseas slowdown in Europe and China has started affecting bond prices in advanced economies and with the slowing inflation in US the pause in any rate hike cycle in US has brought back cheer amongst the bond bulls.
The situation in India is slightly mixed although there has been a decisive policy decision by the MPC members of a rate reduction and the change in stance to neutral, the market is waiting to figure out the balance of the demand in front of the huge supply of gsecs next FY.
While the bond prices have already neutralized by now, any additional round off rate hikes, the rate reduction cycle is yet to be priced in. In the policy document, the RBI Governor has put to rest all opinions around the rise in core inflation and said that only headline CPI mattered and additionally will look forward to reviving growth if the inflation target has been achieved.
The OMO has started to increase the liquidity in the hands of the banks. It is expected that the excess liquidity in the hands of the banks will get onward lent to the corporates including NBFCs and HFCs. However, in the absence of commensurate risk appetite, the flow of liquidity into the affected sector is ebbing, and the credit spreads have widened in the last few months. The recent announcement of recalibrating the risk weights on loans to NBFCs to their credit rating is a welcome step and expected to increase the flow of credit from banks to NBFCs.
In the given market conditions, we urge investors to start selecting funds in alignment with their investment horizon and marginally longer depending on their individual risk appetite. With the drop in the headline CPI and a lower CPI forecast for CY20 (under 4%) we do expect further reductions in the repo rate over time. Hence some additional duration over the investment horizon should work in favour as the risk return matrix is tilted in favour of rates. The risks to this view emanate from the borrowing calendar of FY20. Any additional rate reduction to support growth, will be positive for bond investors.
Over the last few months, incrementally based on the data print, we have been bullish on interest rates and hold on to our stance for a need for tighter real rates and endorse efficient allocation of capital and savings/investment. The market, in due course, is expected to move in sync with the Monetary Policy Committee (MPC’s) rate decision, which is expected to take cognizance of developing inflation and growth dynamics.
Last Updated: 15th January 2019
Next Update On: 15th February 2019
Update Frequency: Once Every Month