It’s not really been a cracker of a year and indices are celebrating near new highs with less fireworks. However, the market liquidity is back just in time to welcome the festival of lights. Whether it was destined or not, we are not sure! Coincidentally, two Governors have been instrumental in bringing back cheer and optimism to the Indian bourses. On one end was the surprising taper delay by the US Fed Governor. On the other was the INR stability, largely the outcome of the new RBI Governor’s FCNR-B deposits limit hike and the ensuing swap facility, that immediately turned FIIs into net buyers of Indian equities in September and October (In the preceding three months, they were net sellers).
A litany of fresh hopes has further improved the sentiment in anticipation of what lies ahead. There is a strong feeling among market participants that India’s Current Account Deficit (CAD), third largest in the world in absolute terms, will fall in line in the coming months. Official gold imports have drastically fallen in recent months and oil prices are likely to be under check with shale gas discoveries, muted global demand and INR scale back. Exports have also picked up recently. The recent monthly trade data was encouraging to say the least (A mere $6.8bn trade deficit compared to the whopping $17.7bn of the previous year).
More importantly, the previous RBI Governor’s liquidity tightening regime has been reversed. The MSF rate is down by 150 basis points to 8.75%. No wonder, liquidity is on the rise and short term rates have noticeably eased. Yes, Repo rate was raised (and we expect one more hike before year-end) but these pro-active hikes are only expected to check the H1 2014 inflation. By the mercy of the rain gods, the satisfactory monsoon promises improvement in agricultural yield and rise in rural incomes. On the political front, the market is pinning its hopes on a BJP-led Government at the centre (Disclaimer: this is not our political opinion on the quality of governance of different political parties but only a reportage of the discernibly prevalent market perception). While we believe it’s premature to predict a thumping BJP majority just yet, the fact remains that this very hope is driving the market. Likely BJP wins in the state elections of Rajasthan, MP and Chhattisgarh may further boost the current rally.
So, is this the onset of a bull market? Well, there are many macro problems that pose a hurdle to the dream run. We desperately need milestone reforms across several fronts. While the government has indeed taken a few steps, the fact that we are so close to election time makes concrete measures difficult. We are yet to see any action on potentially landmark reforms like putting in place a rule-based system for allocation of natural resources, GST and the like. To make matters worse, interest rates and inflation remain painfully elevated. India’s domestic savings and investment rate is steadily declining, causing a fall in the respective share of financial savings. Asset quality of banks continues to be a worry area. Our research estimates ~1% and ~0.3% deterioration in PSU bank and private bank gross NPAs respectively, in the next year alone. While the CAD is expected to be controlled, the fiscal deficit shows no encouraging signs of any check. We have already spent a disproportionately large budget amount in the first half of FY14. With revenues not growing anywhere close to budgeted levels, coupled with an overshooting subsidy bill (which was under-stated to begin with), serious risks to the fiscal deficit loom large.
Real GDP growth is back to the ‘90s level at 4.4% and showing no signs of bottoming out. No wonder, growth has suffered downgrades by IMF and many other entities. Corporate earnings continue to be under pressure with the current quarter being the fourth consecutive quarter of sluggish performance. With the run-up in markets, valuations are getting rich. For this rally to transform into a bull run, many of the above issues would need to be strongly addressed. Else we could well see indices reverse, sentiments change for the worse and liquidity evaporating from our market in search of greener pastures. But for now, a new high seems round the corner and the liquidity tap is very much on.
The best way to approach this market would be to adopt an asset allocation strategy; broadly, a 60% exposure to fixed income and other assets and 40% to equities. Within equities, we favour companies catering to rural demand, global markets that are recovering and beneficiaries from rupee depreciation.
Wishing you and your families a Happy Diwali and a bright and prosperous Samvat 2070!
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