By: Navneet Munot CFA, Director IAIP and CIO SBI MF
And then came the Japanese! As the Quantitative easing (QE) program of the US Federal reserve got unwound, came a surprise boost of liquidity from Bank of Japan. It’s a bold move from the Bank of Japan to combat deflation. Japan’s public debt is estimated at 225% of its GDP and the central bank is determined to achieve its target of 2% inflation; however, the 10-year government bond trades at a yield of 0.45%. Japan’s largest pension fund (GPIF) has announced its intention of substantial increase in allocation to equities including foreign equities. Stocks zoomed while the Yen fell to a 7-year low.
After a surprise rate cut, the European central bank (ECB) is moving closer to some form of quantitative easing. At some point, austerity may be shown the door as Eurozone struggles to get growth back. Election results in Brazil, the geopolitical situation in Russia and concerns about China and other emerging markets have led to outflows continuing from emerging market funds. They are also impacted by the continued strength in the US dollar and soft commodity prices. India has been an exception as it remains the biggest beneficiary of the fall in global commodity prices, from a macro perspective. India is now a consensus trade in the world on the back of a stabilizing macro, possible revival of growth, diversified investible options and reasonable relative valuations (both historic as well as comparative). The equity markets scaled a new high and closed 4.86% higher over the month. India is today the second best performing emerging market in its peer set for the year.
Rupee appreciated 0.8% during the month. We maintain our view that in an environment of a stronger dollar globally and with RBI determined to increase forex reserves, the rupee is likely to stay under pressure despite robust capital flows. But, it should perform relatively better than its peers.
With assembly elections out of the way, the government stepped up the reform process. Some of the key measures taken include – deregulation of diesel prices, hike in natural gas prices, minor labor reforms, ordinance on coal block auctioning, easing of FDI norms in the construction sector with emphasis on affordable housing and a cut in the non-plan government expenditure. There are expectations on legislative actions such as the constitutional amendment for introduction of GST in the coming winter session of Parliament. We firmly believe that India is unfolding its structural story in this phase of its economic growth. The new regime is slowly but steadily pushing the envelope in terms of necessary reforms and policies that can improve “ease of doing business”. There is a gentle permeation of accountability, transparency and efficiency through all the critical layers of governance which should gain permanency over the medium term.
While some monthly economic indicators have slowed from July-August highs, early signs from the festive sales indicate that consumer confidence is rising and should drive positive demand surprise from the December quarter onwards. Urban consumption indicators seem to be doing better than rural consumption. The opportunity of growth in India remains immense with multiple themes that revolve around changing governance, changing consumer preferences, changing technology and changing ownership patterns. Each of these variables over the medium to long term possesses disruptive traits that can challenge the current market structure. Therefore, the new winners of this story will also be different. We remain believers in investing themes such as branded franchises, manufacturing outsourcing, consumption enablers, beneficiaries of changing technology trends, and innovation led growth. We also expect a revival in the investment cycle driven by infrastructure spending followed by private capex at a later stage. We are confident that our incessant focus on research driven investing allows us to focus on separating these strands to bet on the right businesses and management that would enable us to identify these opportunities early enough to ride the entire wave.
The pressure is mounting on the Reserve Bank to soften its stance on monetary policy given the better-than -expected CPI reading, fall in global commodity prices particularly crude oil, poor credit growth and weaker manufacturing data. The government has been showing a commitment of doing its bit through marginal increase in minimum support prices, cut in diesel prices, pushing direct benefit transfers (DBT) and announcing fiscal austerity measures to keep deficit under check. The new government has stuck to giving low Minimum Support Price (MSP) hikes and keeping freebies in check. As against the 7% and 9% average MSP hikes for the last 5 and 10-year respectively, the government has announced a minimal 4% MSP hike this year. This augurs well for containing food inflation and subsidies.
Bond yields and swap levels have declined sharply with expectations of the RBI stance undergoing a change. The benchmark 10-year bond yield has fallen to a level of 8.25%, lowest since September 2013. The yield curve has flattened substantially with long term bonds performing far better. Foreign investors have pumped in a record $ 22 billion in Indian bonds this year. With their limits for sovereign bonds getting exhausted, demand for corporate bonds has gone up resulting in credit spreads contracting to record lows.
The global deflationary environment as reflected in ultra-low bond yields in the rest of the world has led to aggressive bidding by foreign investors. India offers a high carry with expectations of relatively stable currency and a positive turn in the monetary policy cycle.
Our view has been that it may be a while before RBI considers monetary easing in the backdrop of the new monetary policy framework. However, looking at the CPI data, the global environment, views expressed by members of monetary policy advisory panel and actions by the government as outlined above, possibility of RBI softening its stance has gone up. RBI has announced open market sales of government bonds to suck out excess liquidity and maybe to tame the rally; however, underlying momentum remains bullish. With a subdued credit off-take and improved liquidity, banks’ demand for government securities is likely to remain healthy in the near term.
We have increased duration through exposure to government bonds in our long term funds. We believe the G-Sec market offers better value relative to corporate bonds as credit spreads have tightened substantially. We also have a small exposure to Inflation Indexed bonds (IIB) which at 4% real yield offers good value regardless of directional views on the trajectory of inflation.