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Dear Investors,

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Markets continued to rally during the month of February, with indices gaining 4% during the month. Year to date market are up by 8%.  Key events during the month were the Union Budget presentation for the FY - 2017-18 and quarterly results turning out to be better than expected. FIIs turned net buyers to the tune of USD 200mn vs net sellers in January and whole of last year. This excludes USD1.2bn of investment in HDFC Bank, wherein RBI briefly raised FII limits. Mutual funds were net sellers during the month.

With demonetization temporarily disrupting the business environment and moderating economic growth, the market was expecting the government to respond with a dose of populism (tax cuts, rural packages, rise in tax deduction limits, etc.) in the budget. At the same time, anxiety was high around factors like long-term capital gain tax and service tax hike. Against this backdrop, the finance minister in his third budget has managed to achieve a fine balance without deviating from the fiscal prudence path.
   
The FM provided relief to the low-income individual taxpayers and reduced corporate tax for small companies. The fiscal deficit has been pegged at 3.2% of GDP. Focus is clearly on the rural India. Higher allocation towards MNREGA with emphasis on productive asset creation, higher allocation towards asset creating schemes such PMGSY (Gram Sadak Yojana), rural electrification and enhance agriculture credit were the key highlights.

3Q FY-2017 earning season ended with more surprises than disappointments. Nifty aggregate PAT grew by 10% yoy vs 4% growth in 2Q FY-2017. Many sectors such as consumer products, infrastructure, cement, automobiles showed positive surprise. A few such as industrials, energy and telecom surprised negatively. Most companies spoke about subdued growth during November and December and a likely stable growth in the month of January.

However, IIP contracted by 0.4% during the month of December as compared to 5.7% growth in November. Manufacturing growth fell 2% as motor vehicles and other consumer good production declined. Mining and basic goods growth accelerated to 5.2% and 5.3% respectively. Electricity was the best performing segment with 6.3% growth.

Headline inflation slipped to 3.2% in Jan’17. Once again, the downward move was driven by food inflation falling to 77bps in Jan’17. Core inflation remained at around 5%. Vegetables and pulses were in deflationat -15.6% and -6.6%, respectively. Fuel inflation came in at 3.4% (3.8% the month prior). Services inflation continued to rise at around 5% in Jan’17. Core inflation hardened slightly to 5.1%. Rural inflation cooled to 3.4% from 3.8%, while urban inflation was unchanged at 2.9%. Inflation for 10M FY-2017 was at 4.7%.

In the February bi-monthly Monetary policy, RBI kept the repo rate and CRR unchanged vs. market expectation of 25bps REPO rate cut. The CPI projection for March-17 is likely to stay below 5% and RBI expects CPI inflation to be at 4-4.5% in H1 FY-2018 and 4.5-5.0% in H2 FY-2018. The policy is hawkish as the stance changed from accommodative to neutral and have concern on core inflation, which remains sticky. The committee is also concerned about the tightening of monetary policy in US and its impacts to the emerging markets.

The stance of monetary policy is changed to neutral with caution on core inflation. Therefore, RBI may not cut rates in near future, as RBI believes the lower inflation is mainly due to vegetables. Inflation may harden due to higher crude and commodity prices. We do not expect any rally in the bond market but lower CPI print and fiscal consolidation measures may bring yields down. The uncertainty remains on slippage in fiscal deficit, sticky core inflation and rate hike by US. Markets have rallied over the last two months. Future direction is likely to be decided by the outcome of UP elections. While valuations have inched up, we remain constructive on equities.

 
Sanjay Chawla
Chief Investment Officer
Source: Bloomberg, Economic Times
 
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