“2013 was a tumultuous year for India dictated by falling economic growth, a depreciating rupee, high inflation and tight liquidity conditions. While the year started on a favourable note with lower commodity prices, diesel price hike, low core inflation and interest rate cuts, fears of taper in the US led to notable volatility in the markets – be it equities or fixed income. The worst hit, however, was the rupee which touched a high of 68.825 against the dollar in August from the 61-62 levels seen earlier.
However, the new Reserve Bank of India (RBI) governor Raghuram Rajan launched a slew of measures – hike in import duty of gold, special swap window to attract FCNR (B) deposits and foreign currency borrowings, special window for oil marketing companies to help meet their daily forex requirements, and hike in FII investment limit in government securities and corporate bonds from $70 billion to $75 billion. All these measures paid off and the rupee reverted to 62 levels. From its peak of 68.825, the rupee appreciated by 10% at the close of the year. Despite the gain, the rupee declined by almost 13% against the US dollar over the year.
Since September, the RBI raised interest rates twice by 25 basis points each to curtail inflation. After remaining under 7% for four months, WPI inflation rose due to persistent rise in food prices. Meanwhile, improving trade deficit and a good response to FCNR deposit scheme (which saw an accretion of $34 billion) ensured a reduction in CAD. Moreover, a pickup in exports and a fall in imports dramatically improved the CAD/GDP ratio to 1.2% from a high of 6.7% in the not too distant past. Economic growth looks close to bottoming out, with the GDP rising 4.8% quarter on quarter. However, domestic demand remained weak due to a lacklustre capex cycle.”
According to Soumendra, “Going into 2014, fears over the tapering in the US, the eurozone crisis and outflows from EMs have eased. Markets are better prepared for the taper and investor sentiment is buoyed by expectations of economic recovery across the world. We expect the global economy to improve, albeit uneven at a country level, against improving set of macroeconomic numbers. EMs should be beneficiaries of improving growth in the DMs but could be weighed down by a strong US dollar and FII flows particularly if we see a significant rise in US Treasury yields.
Monetary policy is expected to remain accommodative in the US, UK and Europe. Fed taper will soon be a reality and would in all probability end the easing regime before 2014 ends. Beginning January 2014, the Fed will begin to taper $10 billion of asset purchases every month. It will now purchase $40 billion of long dated treasuries (as against $45 billion) and $35 billion of mortgage backed securities (as against $40 billion). The next Fed chairman Janet Yellen has suggested that rate hikes may not be a possibility till 2015. The ECB and the BoJ will likely lower interest rates and inject liquidity into the system. In contrast, Emerging Economies will most likely tighten monetary policy over the year, with growth momentum and inflationary expectations being the key driver.
Though the economy is still in a low growth phase, it looks close to bottoming out. GDP growth is looking set to better expectations after 10 quarters and is headed higher after hitting a trough of 4.5% for FY14. Liquidity stress is easing as influx of forex has improved liquidity at the shorter end. On the external front, an improvement in trade deficit has helped narrow the CAD. Improved forex reserves on the back of USD34b accretion through RBI swap window for FCNR(B) and bank borrowing have stabilized the INR at 62-63/USD levels, which may have provided some comfort to RBI to start rebuilding its reserves.
We expect 2014 to be a tale of two halves, with the first half driven by anticipation of elections and the second half by the outcome of elections and hopefully some actions on policy and reforms. This could result into a recovery in the economy and we could see a fall in inflation leading to softer interest rate regime, adding to the productivity of the corporate and finally investment led infrastructure segment. A cooling in commodity prices globally could be a contributor too.
Recent state election results were a triumph of growth and governance over dole outs and entitlement, anti corruption issues even overshadowed competence like never before. India looks to be ready to turn a new leaf in sensible policy making in 2014, an important pre-requisite to build confidence and help kick-start the Capex cycle - global investors are keenly looking forward to that as well. We expect growth to pick up, with a favourable outcome in the forthcoming general elections should act as a catalyst for quick recovery.
Return of growth and stability of the currency is a virtuous cycle that feeds into one another and will endear steady FII and FDI flows which should create an environment for stability. Indian retail investors who have been taking out money from equity markets for the last two years will then have a compelling reason to reverse this and participate in the journey of growth and prosperity.”
EXPECT 2014 TO BE A YEAR OF TWO HALVES
“Risk–reward at the start of the year is in favour of lower duration funds such as short term and accrual oriented funds. While tactical rallies are likely given elevated yield levels, for a sustained secular drop in yields, we need to see clarity on policies post government formation. As such, we still believe it is better for investors to be prudent in their allocations – especially given that short end yields are fairly attractive, with much lower risk”, according to Shriram Ramanathan, Head – Fixed Income, at L&T Investment Management.
“As we head into 2014, uncertainty still prevails – in the form of upcoming central elections, fiscal policies of the new government and structural food supply problems which lead to periodic high inflation. However, a couple of positives such as - attractive absolute level of yields, tapering being much less of an overhang, inflation possibly having seen its worst, a structurally lower CAD and hence a relatively more stable rupee do provide some support. While the year could start off as a mixed bag of positives and negatives, we do believe that if a strong government were to get elected, and prudent policies are put in place – the market could see a sharp rally in the second half of the year.
Data dependency will be high, as has been repeatedly emphasised by the RBI governor. CPI Inflation is expected to moderate sharply, however the key is to watch whether it can drop significantly below the stubborn 9% levels seen in the past few years. Important in this regard would be the new government’s resolve to bring down inflation and implement effective supply side responses. The fiscal situation is a concern, and this is despite the government sticking to a fiscal target for FY 2013 and possibly for FY 2014 as well. Over the next three years, a large number of government securities will mature, hence gross supply of government securities is likely to be very heavy. While the uncertainty on the government elections remains, we do expect policy to be well calibrated and forward looking, rather than reactive. The monetary policy framework is clearly changing. Increased emphasis on CPI (vs WPI), equal importance to headline inflation as given to core inflation, reduced usage of open market operations to manage yields and the need to generate a positive real return for savers are some of the important messages that have already become part of this new framework. Also, one can expect a buildup in forex reserves to be a theme over the next few years, and this will act as a guard against further rupee weakening episodes.
From a fund selection and allocation perspective, we think risk – reward at the start of the year is in favour of lower duration funds such as short term and accrual oriented funds. While tactical rallies are likely given elevated yield levels, for a sustained secular drop in yields, we need to see clarity on policies post government formation. Hence, while the second half could witness a sharp rally in yields, we still believe it is better for investors to be prudent in their allocations – especially given that short end yields are fairly attractive, with much lower risk.”
The author is Soumendra Nath Lahiri, Head – Equities & Shriram Ramanathan, Head – Fixed Income
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