market economy report september 2013

Market and economic outlook

05-Sep-201305-Sep-2013

Executive summary

◌ः The rupee has been falling because the dollar hasstrengthened, and due to India’s high CAD.

◌ः The government needs to take steps to attract dollarsthrough NRI bonds and by get PSUs to raise moneyabroad.abroad.

◌ः The rupee may rise to around 60 by March owing tofalling CAD (due to falling gold imports).

◌ः Economic growth in Q1FY14 was the lowest in fouryears.

Executive summary

◌ःWPI inflation has begun to rise due to importedinflation.

◌ः Corporate results (both sales and net profit) in Q1FY14were anaemic.

◌ः The market is offering compelling valuations.◌ः The market is offering compelling valuations.

◌ः To protect your portfolio against the rupee’s decline,you need to have investments in gold and internationalfunds.

◌ः FMPs are a safe avenue offering good returns.

Market outlook

Asset Class Current Levels( as on Sep 03, 2013)

Summary View

Why Risk to our View

Equity Nifty: 5,471.80

Sensex: 18,619.72

Markets will

continue to be

under pressure.

There has to be

conviction that govt.

and RBI can stem

RBI and govt. may

act promptly to

attract foreign under pressure. and RBI can stem

rupee’s fall and

stabilise economy.

Fed’s QE moves could

create added pressure.

attract foreign

flows. QE may be

postponed.

Index watch

Benchmark Change in August (%) YTD change (%)

S&P BSE SENSEX -3.75 -4.15

S&P BSE Mid-Cap -4.38 -25.48

S&P BSE Small-Cap -2.26 -29.66

S&P BSE Capital Goods -13.88 -34.81

S&P BSE Realty Index -10.88 -44.40

S&P BSE Consumer Durables -10.32 -27.25S&P BSE Consumer Durables -10.32 -27.25

S&P BSE BANKEX -9.93 -28.17

S&P BSE PSU -8.44 -31.97

S&P BSE Power Index -7.29 -30.35

S&P BSE FMCG -6.62 7.20

S&P BSE OIL & GAS Index -5.00 -4.33

S&P BSE AUTO Index -3.47 -10.71

S&P BSE Health Care -1.19 10.25

S&P BSE TECh Index 3.89 30.18

Index watch

◌ः The benchmark index, the Sensex, declined once againin August.

◌ः The market will look up only once there is confidencethat the steps taken by the RBI and the government tostem the rupee’s decline have succeeded.stem the rupee’s decline have succeeded.

◌ः A wide valuation gap has emerged in the marketbetween large-cap stocks on the one hand and mid- andsmall-cap stocks on the other.

Index watch

◌ःOn the sectoral front, IT has emerged as a favourite.Both the revival in the US economy and the rupee’sdecline favour this sector.

◌ः Rate-sensitive sectors (auto, realty, capital goods) are◌ः Rate-sensitive sectors (auto, realty, capital goods) aredown in the dumps, more so after tightening ofliquidity by the RBI led to a spike in interest rates.

FII and MF flows in equity market

Month FII investment (Rs-cr) MF investment (Rs-cr)

Jan 22,059.20 -5,212.40

Feb 24,439.30 -847.90

March 9,124.30 -1,550.60

April 5,414.10 -1,422.90

May 22,168.60 -3,507.10

June -11,026.90 -269.00June -11,026.90 -269.00

July -6,253.10 -2,184.30

August -5,922.50 1,349.90

Cumulative 60,003.00 -13,644.30

While FIIs have been pulling money out of the equity market for the last threemonths, MFs have turned net investors after a long gap. Any acceleration in FIIoutflows from the equity market will pose further risks to the rupee.

FII and MF flows in debt market

FII inflows (Rs-crore) MF inflows (Rs-cr)

January 2,947.10 40,651.50

February 4,001.20 40,092.10

March 5,795.10 68,114.30

April 5,334.40 51,854.60April 5,334.40 51,854.60

May 5,969.00 26,840.10

June -33,134.90 64,602.10

July -12,037.60 -23,740.20

August -9,772.90 3,485.90

YTD cumulative -30,898.60 2,71,900.40

FIIs have pulled out money from the debt market in June, July and Augustand are net negative investors YTD. MFs pulled out money only in July andare net positive investors YTD.

Rupee’s steep fall against the dollar

50.00

60.00

70.00

80.00

Rupee against dollar

54.69

65.7168.83

28 August

0.00

10.00

20.00

30.00

40.00

01-Jan-2013 01-Feb-2013 01-Mar-2013 01-Apr-2013 01-May-2013 01-Jun-2013 01-Jul-2013 01-Aug-2013

Price

31-Aug-2013


◌ः The chief problem facing the Indian economy today isthe rupee’s steep fall against the dollar.

◌ः Since the start of May, the rupee is down 22.40%against the dollar.

◌ः The rupee’s decline was triggered once Ben◌ः The rupee’s decline was triggered once BenBernanke, the chairman of the US FederalReserve, spoke of quantitative easing (QE).

◌ः The dollar strengthened on expectation that therewould be less of it in future, and all emerging market(EM) currencies fell against it.


◌ः The rupee’s fall was steeper than that of all other EMcurrencies because India runs a large current accountdeficit (CAD). Investors worry about how it will fundthe CAD.

◌ः Recently the RBI announced changes to the liberalised◌ः Recently the RBI announced changes to the liberalisedremittance policy. It reduced the amount thatcompanies and individuals can invest abroad. It alsoplaced restrictions on property purchases abroad(August 14).

◌ः These steps were meant to preserve India’s foreignexchange reserves.


◌ःBut they triggered the fear that India mightimpose capital controls.

◌ःThis led to further outflows, andexacerbated the rupee’s decline.

Key risks from rupee depreciation

◌ः FII holding in India is at 21% in BSE 200 companies (45%of free float). This makes the Indian market vulnerableto a sell-off in emerging markets.

◌ः Every 10% depreciation of the rupee raises inflation by100 bps. Higher inflation will constrain the RBI's ability100 bps. Higher inflation will constrain the RBI's abilityto cut interest rates and kick start the economy.

◌ः Companies with dollar debt may default. Infrastructurefirms are especially vulnerable. Banks’ NPAs may rise.

◌ः If the rupee falls to 70 and beyond, FII pull-out fromthe equity market may accelerate.

What needs to be done

◌ः The central bank needs to maintain tight liquidity to support therupee, but not so tight that growth gets choked.

◌ः In the short run, India needs to augment its dollar reserves. It caneither get public sector companies to issue quasi-sovereign bondsor launch NRI bonds.

◌ः Both foreign equity investors and NRIs would be interested in◌ः Both foreign equity investors and NRIs would be interested intaking advantage of the weak rupee.

◌ः In the longer run, the government needs to create an environmentthat attracts more FDI than unstable FII flows.

◌ः Capital surplus countries like Japan are keen to invest in India'sinfrastructure.

What needs to be done

◌ः Improve trade relations with Iran. This will allow Indiato buy oil in rupees instead of dollars.

◌ः◌ः Implement the government’s welfare projects better sothat they increase productivity, instead of just leadingto higher inflation.

When will the rupee recover?

◌ः According to rating agency Crisil, the rupee will recoverto around 60 to the dollar by the end of FY14 from itscurrent level of above 65.

◌ः This will be driven by an improvement in CAD. CAD hadcome in at 4.8% in FY13. Crisil expects it to fall to 3.9%come in at 4.8% in FY13. Crisil expects it to fall to 3.9%in FY14.

◌ः The fall in CAD will be driven by a decline in non-oilimports, chiefly gold.

◌ःGold imports will fall because of the increase in importduty from 8 to 10%, and the restrictions imposed by thegovernment on investing in gold coins and gold bars.

When will the rupee recover?

◌ः Import of consumption items and capital goods may also fall due toweaker domestic demand.

◌ः CAD is now expected to be $71-72 billion in FY14.

◌ः But India will have difficulty in providing for even this lower amountof CAD. That is why it is expected that the rupee will be 12-14%weaker by the end of FY14 compared to the end of FY13.weaker by the end of FY14 compared to the end of FY13.

◌ः If the government takes immediate measures to encourage foreigninflows (issue NRI bonds and get PSUs to borrow abroad) that too willhelp the rupee.

◌ः The risk to its forecast, according to Crisil, comes from how thetapering of QE3 will pan out.

◌ः According to Crisil, it is likely to begin in the Oct-Dec quarter of 2013.If it proceeds at a fast pace, it could affect inflows into emergingmarkets, and have an impact on EM currencies, including the rupee.

Slowing economic growth

◌ः The Indian economy grew by just 4.4% in the April-June2013 quarter.

◌ः This was the slowest quarterly expansion in four years.

◌ः All the components of aggregate demand remainedsubdued: government, private consumption andsubdued: government, private consumption andinvestment.

◌ः Both manufacturing and mining contracted. Whilemanufacturing had grown 2.6% in the previousquarter, it slumped to 1.2% in the first quarter.

◌ः The mining sector registered a decline of -2.8% in theJune quarter compared to a decline of -3.1% in theprevious quarter.


◌ःSome segments of the service sector have alsobegun to falter.

◌ःThe only saving grace is that a good harvest isexpected this year because of a good monsoon.expected this year because of a good monsoon.This will lead to higher rural income, whichshould in turn boost consumption.

◌ःThe PM remains hopeful of a 5.5% growth in FY14, but this appears unlikely.


◌ः Recent steps by the RBI to tighten liquidity (in order tosupport the rupee) may further hurt growth prospects.

◌ःGDP growth may improve from the second or thirdquarter once higher government spending makes animpact on the economy. In the first quarter of thisimpact on the economy. In the first quarter of thisfiscal, the government has released 48-50% of the totalplan expenditure for the year.

◌ः Between January and April the Cabinet Committee onInvestments (CCI) has approved projects worth $ 27billion.

Inflation inches up

◌ःWPI inflation was 4.6% in May, 4.9% in June, and thenaccelerated sharply to 5.8% in July.

◌ःNon-food manufacturing or core inflation, which hadsoftened to 2% in June, rose to 2.4% in July. This wasthe result of the rupee's depreciation, which is causingthe result of the rupee's depreciation, which is causingimported inflation.

◌ःHowever, due to reduction in the pricing power ofmanufacturers (weakened demand due to higherinterest rates), the underlying trend in core inflation isexpected to be benign in FY14.

Inflation inches up

◌ः A good monsoon is expected to result in a good kharifharvest and lead to softening of food prices in FY14.

◌ः◌ः The rupee's depreciation could cause import inflation.However, its pass-through effect may to some extentbe blunted by weak domestic demand.

Oil prices up again

◌ः Another risk to the Indian economy has arisen with theprice of oil strengthening.

◌ःWith tensions in the Middle East rising, Brent crude has◌ःWith tensions in the Middle East rising, Brent crude hasrisen about 14% since April. This will again keep India'stwin deficit problem in focus, leading to furtherweakness in the rupee.

First quarter results

◌ःNet sales of Sensex companies continued to deceleratein the first quarter of FY14 to 1.7% y-o-y. This is thelowest level since the global crisis of 2008.

◌ः This low sales figure confirms weakened demand within◌ः This low sales figure confirms weakened demand withinthe economy.

◌ःNet profit of Sensex constituents declined to 1.9% y-o-yin the first quarter of FY14.

First quarter results

◌ः The sectors that had high sales in the first quarter werehealthcare, IT and telecom. Those with poor salesincluded industrials, metals and mining.

◌ः Sensex PAT growth was skewed in favour of◌ः Sensex PAT growth was skewed in favour ofhealthcare, IT, and FMCG. Industrials, oil and gas andtelecom posted poor profits.

◌ः According to Kotak Securities, Sensex earnings willgrow 8.2% in FY14 and 14.5% in FY15.

Valuations have turned compelling

◌ः Free cash flow yield to enterprise value of the Sensex isat around 8.5-9%, which is close to the 10-year bondyield.

◌ः Sensex is trading at about 14.5 times FY14 EPS and◌ः Sensex is trading at about 14.5 times FY14 EPS and12.7 times FY15 EPS.

◌ः The market has got bifurcated. Defensive stocks aretrading at high valuations and rate-sensitives are atrecord lows. The price of the latter may not pick upunless there are signs of a turnaround in the economy.

WHAT SHOULD YOU DO?

Gold acting as a hedge

20000.00

25000.00

30000.00

35000.00

40000.00

Price

30,78032,25034,130

,28 Aug.

0.00

5000.00

10000.00

15000.00

20000.00

Price

31-Aug-2013

Have an allocation to gold,

the classic hedge

◌ः If you had at least a 10-12% allocation to gold in yourportfolio, it would have acted as a hedge against therupee’s fall.

◌ः As the rupee fell, the value of gold, most of which is◌ः As the rupee fell, the value of gold, most of which isimported from abroad, rose.

◌ः Since the start of the year it is up only 4.78%.

◌ः But from its nadir this year of Rs 25,018.50 on 28June, it has rallied 28.90%.

Invest in international funds

◌ः Another way you could protect your portfolio againstthe rupee’s decline is by investing in internationalfunds.

◌ः About 15% of your equity portfolio may be invested inforeign equities.foreign equities.

◌ः 50% of your money in foreign markets should beinvested in the US market and the balance in emergingmarkets.

◌ः If you are new to international investing, begin withETFs. They have low cost and offer you abroad, diversified exposure.

FMPs offer safety and returns

◌ः Interest rates within the economy shot up after the RBIintroduced liquidity tightening measures to stem therupee’s fall.

◌ः The mutual fund industry has responded by launching alarge number of fixed maturity plans (FMPs).large number of fixed maturity plans (FMPs).

◌ः They are close-ended products with no mark-to-marketrisk.

◌ः Investors may invest in them to take advantage of thecurrent spike in interest rates. If you hold them formore than one year, the tax rate is also morefavourable compared to fixed deposits.

Thank you

market economy report september 2013

Economy & Finance