By: Navneet Munot, CFA, CIO, SBI Mutual Fund and Director IAIP
March witnessed positive returns across all asset classes. Equity market rallied 10%, bond yields have dropped 16bps, most commodity prices inched up and rupee nearly recouped the losses made since the start of the year. Both global and domestic developments triggered these gains.
Globally, firming up of crude prices in March boosted the global market sentiments. Further, the recent dovish statement by US Federal Reserve chief Janet Yellen was unexpected and re-ignited the skepticism on strength of US growth. To sum up, lowering of market expectations on US recovery and firming up of oil prices led global investors to cautiously realign their investment in emerging markets and consequently India. FIIs have bought US$ 2.9bn from Indian debt and equity markets during the month.
The unprecedented monetary accommodation practiced by the central banks in the developed world since the 2008 financial crisis is reaching the end of its limit in achieving the desired economic growth. The recent response of markets to incremental QE announcement by ECB and Bank of Japan also reflect that probably monetary policy has already reached its maximum potential. It is time for the governments to return to the fiscal policy and structural reforms. Productive fiscal policies in the form of capital spending will not only general employment, thus boosting income, but also crowd in private investment. And if, indeed, the current problem is lack of business participation to revive growth, only fiscal policy, not monetary policy, could work to fill the deficiency in demand.
In a sense, there is a need to shift back to the Keynesian orthodoxy which saw fiscal and monetary policy as two wheels of the policy bicycle to push in the same direction. Government’s balance sheet capacity may be limited in several cases but given the negative bond yields and low expected returns in global equities, pension funds may find infrastructure as an attractive asset class to invest. Low commodity prices and technological changes will help in improving project viability. Infrastructure spending which has been vastly neglected for a long time could be the panacea for treating several ills of the global economy.
On the domestic front, market returns validated the growth focused budget and host of positive policy developments undertaken by the government ranging from passing the Aadhar bill, establishment of Bank Board Bureau (BBB), pushing the implementation of Bankruptcy code and implementation of UDAY which aims to resolve the financial and operational predicament of power distribution companies.
The structural problem on banks’ balance sheet is in its last leg with the regulatory cleansing and the impending sanction of the Bankruptcy code. Corporate sale down of assets to deleverage their balance sheet has accelerated.
We think that some bit of market rally also had to do with correction of excessive pessimism priced in the market since the start of the year. To that extent, the current gain could be easily retraced by a sudden return of risk-off investor sentiment on the back of any macro development especially pertaining to China, commodity, Brexit and US interest rates. Global environment today, sits amidst increased volatility. Even locally, while policy push may revive market hope in the interim, in the end, it is imperative that these measures translate into better corporate earnings.
In all likelihood, the pain-points in earnings will be visible in this quarter again. But, the policy push and stable macroeconomic environment makes us confident of 14-15% growth in corporate profitability over the next couple of years given a low starting point.
While keeping an eye on the macro developments, we remain focused on bottom up stock picking which we believe is the best way to generate alpha on a sustainable basis.
In its latest monetary policy meet held on April 5th, RBI delivered a 25bps rate cut and announced its intentions to progressively lower the deficit in the banking system liquidity. There are reasons to believe that the sea-change in RBI’s stance on liquidity will have a much stronger impact than conveyed by the headline number of 25 bps rate cut. The overall policy is structurally very positive for the economy. The central bank stated that it will ensure that durable liquidity in the system is closer to neutral versus an earlier deficit of 1% of NDTL. Additionally, it lowered the minimum daily cash balance to be maintained by banks from 95% to 90% (with effect from 16 April 2016) and reduced the LAF interest rate corridor to +/- 50bps vs. +/- 100bps previously. All these measures, along with an earlier implementation of MCLR lending rates rules by banks and market alignment of small savings rates by government are likely to aid better monetary policy transmission.
RBI has committed to infuse durable liquidity (OMO/FX purchases) on a regular basis irrespective of short term liquidity movements, with a Rs 15,000 crore of OMO purchase conducted the very same day. RBI will use short-term liquidity measures to only address short-term liquidity constraints. In light of these policy developments, we expect the short-term money market rates to ease significantly and be in closer alignment to Repo rate. The front end of the curve is likely to remain well-bid given the liquidity infusion on a structural basis and looks attractive from a valuation perspective.