Politics and return to growth to be the key: L&T MF

Going into 2014, fears over the tapering in the US, the eurozone crisis and outflows from EMs have eased

January 07, 2014 4:54 IST | India Infoline News Service
The year 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.

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.

The writer is Head–Equities, L&T Investment Management.

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