Debt
Market Scenario
Rising
interest rates
The
Reserve Bank of
India (RBI) increased the Repo Rate and Reverse Repo Rates by 150 basis
points
and 200 basis points (bps) respectively in 2010. The monetary
tightening was an
outcome of inflationary pressures from domestic side as well as global
factors.
Going ahead,
RBI may
find it
difficult to meet the inflation target of 5.50% by March 2011 and
inflation would
persist for some time.Hence, we expect that the Central Bank would
increase
Repo and Reverse Repo rates further by 50 bps in the first three months
of
2011.
Although
inflation is a
major
concern now, we are of the opinion that the inflation data will show
moderation
in the second half of 2011 on account of good monsoon and base effect.
In
addition, we also expect the growth in the economy to moderate next
year, FY
2011-12, which will make the Central Bank to go in for a pause in the
rate
hikes in the second half of 2011.
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Chart 1:
Policy Rates
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Liquidity
crunch
At present, Indian
debt
market is
facing huge liquidity crisis. In the month of November and December,
banks have
been borrowing daily, on an average, more than INR 1 trillion and INR
1.2 trillion
respectively from RBI.
The liquidity
crunch has
been on
account of following factors:
- Large Government
surplus
averaging INR 840 billion gained from 3G
auction and buoyant tax
collections that has been lying with the RBI since the second quarter
review of November 2010
- Huge equity issuance
in
the form of Initial Public Offering and Follow on Public Offers and
- Sluggish growth in
bank
deposits despite the accelerating credit growth
We
expect that liquidity to remain tight
for some more time, but in the run up to March 2011, the borrowing of
the
government for FY 2010-11 will be completed and the huge government
surplus
lying with the RBI will be infused into the economy in form of
government
expenditures. These factors should ease the short-term and long-term
rates.
The Union Budget FY2011-12
would have a significant impact on fixed income markets in 2011.
Several
factors such as the borrowing calendar of the government along with the
fiscal
deficit roadmap and the disinvestment plans for 2012 will be the
crucial
factors that would decide the movement of bond yields.
High
Yields
Due
to the six
continuous rates hikes by the Reserve Bank of India (RBI) in 2010 and
the
severe liquidity crunch faced in the system since the last few months,
the bond
yields have increased sharply. In the
last 18 to 20 months, yields on the short-end and the long-end of the
curve
have significantly moved higher. On the 10 year G-Sec paper, the yields
have
risen by 180 basis points (bps) and on the Certificate of Deposits of
time
period between 3 and 12 months, the yields have risen by 400 to 500
bps. The
yields on 3-12 months Commercial Papers have also risen by 400 to 550
bps.
FII
limits
eased
The FII limit
in the bond market has been increased to US$30 billion and the impact
of this
measure would be seen in 2011. The increased FII limit will definitely
help in
easing the liquidity situation in the market. The FII inflows into the
Indian
market are approximately US$9 billion (Year-to-Date) as against US$1
billion in
2009.
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Chart 2: Yield of
Various
Debt Securites
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Implication for Investors
Fixed
Maturity Plans
- Fundsupermart.com expects the short-term
rates to go down in the second half of 2011 with RBI going slow on rate
hikes and easing of liquidity. In this scenario, it would be advisable
for investors to lock in money in Fixed Maturity Plans (FMPs)
as they can take advantage of prevailing high yields. Plus, there is
negligible impact of interest rate movements as the portfolio is held
till maturity. In addition, they are tax efficient,
as they are taxed at 10% without indexation and 20% with indexation. Thus, the returns given by the FMPs post tax
would be more than net yield from Fixed Deposits. There is also double
indexation benefit, if investments overlap 2 financial years. Thus, investors having a time
horizon of 3 months to 2 year time horizon can consider Fixed Maturity
Plans (FMPs).
Ultra Short Term Funds
- Investors whose money idles in their
savings account for over a month can consider Ultra Short Term Funds
as an alternative. The return earned on a savings account is only 3.5%
per annum, while for Ultra Short Term Funds, an average return falls in
the range of 4.5%-5% or at times even more. From taxation side, the
interest income from savings account is added to the individual’s
income, whereas for Ultra-Short Term, the Dividend Distribution Tax is
14.16% including surcharge and education cess.
- Our recommended Funds in the
Ultra-Short Term Funds are DWS
Ultra Short Term Fund, Birla
Sunlife Ultra Short-Term Fund, BNP
Paribas Money Plus Fund.
Outlook
on Equity
- Neutral on
Indian Equities on account of the following factors:
- Sensex is
overvalued in terms of historical and relative valuation.
Historically,
the fair P/E of Sensex has been around 17X, whereas we are currently
trading above the
historical levels. Expected EPS of Sensex by March 2011 is around 996
which translate
into a P/E of 19.94X.
- Year-to-Date
(as at 30 November
2010), FIIs have already pumped in around US$ 28.91 billion
into Indian
Equity market. Any reversal in the FII inflows due to the
uncertainty in
the global economy could severely impact the Indian market.
- The huge
FII inflow has led to Rupee Appreciation, which has reduced the
attractiveness
of Indian exports. If the Central Bank resorts to capital controls to
hold the
inflows, then there would be a sharp correction in the Index.
- In the year 2010, RBI has
hiked
rates six times, the impact of which will be seen in terms of
moderation in the
GDP data in the coming quarters, which will affect the profitability of
Indian
corporate sector.
Implications for Investors
Mid-cap Funds
- Investors should look at mid-cap
funds as this category is expected to deliver better returns than
their large cap counterparts. This is because the midcap index is
currently trading 25% below its previous all-time highs. In this
scenario, fund managers will definitely look out for quality stocks in
the mid-cap space which are available at attractive valuations.
- Our Recommended Funds in
the Mid-cap Funds are HDFC
Mid-cap Opportunity Fund, and DSP
BlackRock Small & Midcap Fund.
Infrastructure
and Banking Sectors
- We are positive on the infrastructure
and banking space. Although the
infrastructure sector has underperformed in 2010 on account of reduced
capital expenditure and global recession, we feel that the expected GDP
of 8.70% in 2011 can be achieved only with huge spending on this
sector. In the Twelfth Five year Plan (2012-2017), Government is
planning to spend about US$1 trillion into the infrastructure space. If infrastructure is the favored sector with the government
then it will be the banks, which will be the key financiers of the
infrastructure projects. Although RBI expects credit growth to be
around 20% by 2011, we are of the opinion that the figures will be
higher on account of companies reviving their capital expenditure plans
and higher disposable income with the masses. The credit growth as at 3
December 2010 has already reached 22%.
- Our Recommended Funds for the
Infrastructure and Banking Sectors are ICICI
Prudential Infrastructure Fund, DSP
BlackRock India T.I.G.E.R Fund and Reliance
Banking Fund.
FMCG
and Healthcare Sectors
- FMCG and Health Care sectors have outperformed BSE Sensex
in 2010 and we expect these sectors to continue their outperformance in
2011 at the back of the strong consumption growth especially in the
rural segment. Plus, there is growth potential in the generic market
along with the consolidation that is expected in the Pharmaceutical
space.
- Our Recommended
Funds for the FMCG and the Health Care categories are Magnum
Sector Umbrella Fund - FMCG and Reliance
Pharma Fund.
Global
Funds
- Since global corporate earnings are
expected to hit record highs by the end of 2012, we advise investors to
take exposure to global funds. Fundsupermart is of the view
that the global economy will continue to recover in 2011 as well, and
we are very positive on the emerging markets and believe that countries
like China will be the main drivers of global economic growth.
Investing in global funds is relatively new to Indian investors. Most
of the Indian investors have a concentrated India portfolio largely due
to the fact that mutual fund / investment offerings in the country have
been centered on the domestic market. Now that more international funds
have come in through the feeder funds route, we are of the opinion that
entering into these funds will not only help in geographical
diversification, but also reduce the overall portfolio risk.
- Our
Recommended Funds in the Global Funds categories are Mirae
Asset China Advantage Fund and Principal
Global Opportunities Fund.
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