Pause in Interest Rates
The Reserve Bank of India (RBI) has raised its Key Interest Rates 13 times since early 2010 and has paused now expecting Inflation to come down and looking at Growth numbers. The RBI kept the benchmark Repo Rate unchanged at 8.5%, Reverse Repo Rate unchanged at 7.5% and Cash Reserve Ratio unchanged at 6% in its recent ‘Mid Quarter Review of Monetary Policy 2011 – 12’.
The RBI policy in the last two years has been focusing on inflation in the economy in varying degrees. Now, the focus has started to shift to growth as stated by the RBI that “downside risk to growth have clearly increased”.
Going forward, monetary policy cycle is likely to reverse from this point responding to growth concerns. The inflation risks remain high and thus under watch. The future movement of Rupee and Inflation will determine magnitude and extent to cuts. We are of the opinion that the inflation data will moderate slowly by March 2012 due to base effect.
Index of Industrial Production (IIP)
India’s Industrial Output fell for the first time in 28 months on the back of falling consumer demand and declining corporate investments. IIP for October came in at -5.1%, the lowest reading since March 2009.
A low industrial production number would make achieving GDP growth of 7.5% extremely challenging. We expect IIP to continue to be bashed down with lower exports, high interest rates deferring most new investments.
Gross Domestic Product (GDP)
India's July-September quarter (Q2) GDP grew 6.9%, slowest growth in nine quarters. The economic deceleration is expected to continue in October-December quarter (Q3). Growth is slowing down more significantly that what is possibly being assessed by policymakers. The sovereign debt problems in Europe and global slowdown were also impacting India's growth. Given that global macro-environment has deteriorated sharply over the last few months; the domestic slow down should become more and more apparent from here.
In our view, over the next 6 months RBI policy will move from inflation management to growth management. In that context, we expect the RBI to start easing monetary policy somewhere in the April – September 2012 half year.
Wholesale Price Index (WPI)
The RBI has raised policy rates by 375 basis points since March 2010 to combat inflation, which has not fallen below 9% for the past 11 months, but is now beginning to show signs of easing. Food inflation, a big driver of headline inflation eased to 6.6% in middle of November 2011, a near three-and-half-year low. Inflation has moderated due to decline in primary food articles. The non-food manufacturing and fuel group inflation has remained elevated.
There is a scope for moderation in inflation and we expect WPI to trend down, leading up to 6.5% to 7% by March 2012.
Widening of Fiscal & Current Account Deficit
A slowdown in revenue collections and higher spending on subsidies may make the Government challenging to achieve the fiscal deficit target of 4.6% of gross domestic product in the fiscal year ending March 2012. The currency also depreciated because of large current account deficit. Food subsidy bill will add on to already weak current account deficit. Higher government borrowings could crowd out private sector demand for funds and investment.
India's current account deficit is expected to widen further. The higher fiscal deficit and low growth might bring India into rating watch.
Falling Bond Yields
The Benchmark 10-Year Government Bond Yield raised to high 8.97% in the month of November 14 of this year on the back of hiking Policy Rates by RBI since March 2010. But in its latest mid-quarter monetary policy review, RBI had left interest rates unchanged and guided that further rate increases might not be warranted. The Yield on the Benchmark 10-Year G-Sec Bond has retracted from almost 9% in early November to 8.30% - 8.40% presently.
We expect the Yields on Government Securities to fall further on the basis of Interest Rate falling downwards and liquidity-easing measures by RBI.
Chart 2: Yield of
Fixed Maturity Plans
- We expect the short-term rates to go down in near future with RBI cutting Policy Rates 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 1 year time horizon can consider Fixed Maturity Plans (FMPs).
Long Term Income Funds & Gilt Funds
- We go positive on Income Funds and Gilt Funds as the benefits of downward interest rate movement will accrue to longer duration funds in larger magnitude.
- In the near future, as we expect the fall in interest rate regime, Long-Term Income Funds and Gilt Funds are likely to provide decent returns. The fall in bond yields as well in interest rates, will benefit both these categories, as they increase their average maturity. Long Term Funds & Gilt Funds give a better return than Short Term Funds on falling interest rate scenario. Investors should look for this category so as to take advantage on change in interest rate scenario. One should ideally stay invested in these categories till the falling interest scenario saturates.
- Our recommended Funds in Income Fund Category are ICICI Prudential Income Plan and Birla Sun Life Dynamic Bond; and in Gilt - Long Term Category is ICICI Prudential Gilt Fund Investment Plan.
The outlook on long term is really promising for equity as an asset class. While, we are cautious on Indian Equities on short term and believe that first half of 2012 will be challenging for equity investors. Following factors can be look at:
1. Investors sentiments are at historic low in 2011; MF Equity funds witnessed consistent net inflows
Indian equity markets are down by close to 23% year to date in absolute terms. Cash turnover for equity has declined to seven year low and cash turnover to market capitalization is lowest since 2000. FIIs have sold approx. $ 5.4 billion worth of equity in 2011 against $ 17.5 billion of net buying in last year. The domestic financial institutions are the net buyers in current year. In spite of so much of pessimism, the equity funds have received net inflows in 2011 and which is the highest net inflow in last 4 years. And the flow to equity funds is mostly via Systematic Investment Plans (SIPs). That shows investors are optimistic about the long term performance of equity markets.
Table 1: Net inflows of Equity Funds (excluding ELSS and Equity ETFs)
||Amount (in Rs. Crore)
|FY 2012 YTD
Source: AMFI, iFAST Compilation
2. Softening in crude prices could be the supporting trigger
Crude constitutes close to 70% of the India’s import bill and India is a trade deficit country. Most of the commodity prices have witnessed significant decline in recent months owing to the slowdown in global economies. But crude oil prices are relatively up. The recent softening in crude prices was negated by the depreciation of rupee against dollar. The continuous downward pressure on rupee will have negative impact on India’s fiscal deficit which is already at high level.
If crude prices decline from current level will improve India’s current account & fiscal deficit and will also help in curbing inflation. Even if, rupee improves from current level will reduce the landing cost of crude oil in India which looks unlikely in near term.
3. High inflation and high interest rate that has slowed the economy will turn benign and accommodative
The consistent high inflation and tight monetary policy for almost 2 years has weakened the economy faster than the anticipated. The Industrial Production number for Oct 2011 came at -5.1% worse than the market expectation. 3Q FY 2012 GDP slowed to 6.9% and economists are reducing the growth forecast for FY 2012 and FY 2013.
Inflation slowed to 9.11% in Nov 11 but still above the comfort level of RBI. The food and non food inflation have slowed significantly in recent release. We believe that Inflation will slowdown to 7 – 7.5% level till financial year end majorly due to the base effects. We can expect accommodative monetary policy by RBI in first quarter of FY 2013 as RBI has already hinted it by pause in the rate hike in its quarterly monetary policy review. But we don’t expect RBI to start cutting rates in hurry.
4. Government will push private investment to revive economy
India needs investments to revive the slowing economy. We believe that government will not take measures like fiscal easing or special packages like measures taken in 2008 & 2009. As these measures will aggravate the already high fiscal deficit and also increase the domestic consumption level which will worsen the fight against inflation.
The private investments have significantly declined in last 2 - 3 years. We believe that government will take appropriate steps to boost the private investment. Which can be infer from creating a special cell to fasten the process of land acquisition for power companies.
5. Valuations are attractive
Sensex valuations are attractive in terms historical valuations and relative valuations. Historically, the fair P/E of Sensex has been around 17X, whereas we are currently trading at 13.86X as on 20 Dec 2011 well below the historical levels.
Our estimated EPS for 2011-12, 2012-13 and 2013-14 are 1162.3, 1348.19 and 1536.94 respectively which translates into the forward P/E of 13.06X, 11.26X and 9.87X.
- Investors should look at mid-cap funds as this category is expected to deliver better returns than their large cap counterparts on more than 3 years investment horizon. This is because the midcap index and small cap index are currently trading at close to 50% and 60% respectively below its previous all-time highs. Historically, the average P/E of BSE Midcap Index has been around 16X, whereas we are currently trading at 11.67X as on 20 Dec 2011 well below the historical levels. The historical high P/E multiples for BSE Midcap Indices is close to 23. 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, IDFC Sterling Equity 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 and 2011 on account of reduced capital expenditure and global recession, we feel that the expected GDP of above 8.0% in coming years 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. That apart, softening in interest rate will increase the loan book of banking system and also improve the loan quality.
- Our Recommended Funds for the Infrastructure and Banking Sectors are ICICI Prudential Infrastructure Fund, AIG Infrastructure and Economic Reform Fund and Reliance Banking Fund.
FMCG and Healthcare Sectors
- FMCG and Health Care sectors have outperformed BSE Sensex in 2010 and 2011 YTD. We expect these sectors to continue their outperformance in 2012 also 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 Funds Umbrella-FMCG Fund and Reliance Pharma Fund.
- We believe that technology funds will outperform broader indices in 2012. Although there is revenue pressure and margin pressure on Indian IT companies due to slowdown in global economies. But the depreciation of rupees against dollar will have net positive impact on these companies. If rupee trades above 48 per dollar will have positive impact on IT companies.
- Our Recommended Funds in the Technology Funds categories is Franklin Infotech Fund.
- Fundsupermart is of the view that the global economy will extend its growth in 2012. We are very positive on the global emerging markets that are trading at attractive valuations and have good upside potential on 2 – 3 years. 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 Funds in the Global Funds categories are Mirae Asset China Advantage Fund and Franklin Asian Equity Fund.