India Monthly Investment Outlook and Strategy. July 2012

Transcription

1 India Monthly Investment Outlook and Strategy July 2012

2 Contents 1. Macroeconomic Outlook 2. June Recap 3. Asset Classes- 12 Month Views India - Equities India - Fixed Income Currencies Commodities Best Private Bank in Asia Asset Allocation 5. Recommendations Equity Stocks Advisory Portfolio Mutual Funds - Equity / Fixed Income Bonds

3 Macroeconomic Overview Global Volatility to remain high in the short term, fundamental long term picture holding for now Global economic outlook The short-term outlook for the global economy remains fragile, although a number of factors are likely to bring support to growth in the second half of the year. Oil prices have come down, easing inflation pressures Monetary policy remains very accommodative The US housing market seems to be recovering Worries about a Chinese hard landing continue, but our base case scenario remains a soft landing. On the bright side, inflation is also coming down faster than expected and policymakers have started adding stimulus to support growth, including an interest rate cut. Inflation is becoming less of a concern for markets as it does seem to be peaking. In the developed world, slowing growth is likely to continue to bring inflation down in the coming months Even in the emerging markets (EM), where inflation has been stickier due to high food prices, there are signs that inflation has peaked across most of the region. This should allow more central banks to cut rates, helping to support economies from the Western slowdown. Investment Implications A number of key questions remain unanswered, in the hands of politicians and central bankers. As such, we expect short-term volatility to persist and believe it is still too early to add significant risk to portfolios. Nonetheless, we believe the longer-term outlook is starting to improve.lower oil prices, falling inflation, accommodative monetary policy and some growth initiatives should lift economic growth later on this year. For now, we maintain a neutral view on equities, bonds and commodities, but we remain invested in quality assets and diversified across asset classes in anticipation of more optimistic times. Within equities, we retain our positive stance on US and emerging market equities, both of which enjoy economies that are growing, and have valuations that are still below long-term averages. We believe gold may remain range-bound in the short term as a stronger USD poses obstacles to price appreciation. Source: RBI/HSBC Global Research/Bloomberg

4 Macroeconomic Overview India Reserve Bank of India was right to hold rates, despite a slow down in growth Facts: In its June meeting, the RBI kept the policy rate (the repurchase or repo rate) unchanged at 8.00%, against consensus and our call for a 25bp rate cut. Consequently, the reverse repo and marginal standing facility rates were kept unchanged at 7.00% and 9.00%, respectively. The cash reserve ratio (CRR) was left unchanged at 4.75%, as expected. However, the RBI increased the limit of export credit finance from 15% of outstanding export credit to 50%, which according to the RBI would release over INR 300 billion, equivalent to around 50bp cut in the CRR. This was despite the fact that data released since the last RBI meeting have been somewhat weaker than the RBI had envisaged and has confirmed that India s potential growth rate has taken a hit. The Jan-Mar GDP number was probably the biggest disappointment for the RBI. Growth eased to 5.3% y-o-y (versus 6.1% in Q4 2011), well below consensus and our estimate of 6.1%, and the lowest reading since This lowered FY2012 (Apr 11 Mar 12) GDP growth to 6.5% versus 8.4% in FY11. Indicators for the Apr-Jun quarter have generally improved in sequential terms, but they also show that the economy has entered a slow-growth period by Indian standards. Industrial production was flat in April (0.1% y-o-y vs. -3.2% in March). This was weaker than consensus but in line with our forecast. HSBC's India manufacturing PMI however has picked up marginally to 55.0 in June (vs in May), Implications: A rate cut at this juncture would have had little, if any, impact on lending rates as banks would have been reluctant to pass them on. Importantly, a cut would not have done much to support growth even if lending rates had been reduced by the full amount of the rate cut. The key reason for this is that the slowdown in growth, to a large extent, has been driven by the supply side of the economy, which has suffered due to insufficient progress on structural reforms. Policy paralysis has also hurt the supply potential by weakening the investment cycle. A rate cut is, consequently, not the right medicine to cure what ails India's growth. Another rate cut would also have added to inflation risks given the lack of slack in the economy. In our assessment, the economy is operating close to its full potential despite the slowdown in growth. Stimulating demand through rate cuts when supply is constrained by structural impediments - could therefore easily lead to higher inflation. There are other sources of inflation risks. The weaker rupee implies higher imported inflation. In addition, the government will eventually have to raise diesel and kerosene prices to contain the subsidy bill. Combined with the knock-on effects from the hike in excise and service tax rates, this is expected to lift inflation and possibly inflation expectations. India's twin deficits - fiscal and current account - also rightly made the RBI think twice about cutting rates further. While it is true that the government delivered a tighter budget for the current fiscal year, it may not be able to tighten the fiscal reins as much as it hoped. This may effectively leave overall macroeconomic policy too loose. The wide trade deficit is another reason to avoid stimulating domestic demand through easier monetary policy, especially in the context of weak external demand and high global risk aversion. Hence, In light of the weaker global economic backdrop and slower domestic growth, whilst RBI may feel tempted to ease policy rates, a rate cut is not likely to prove very effective given the impairment of the transmission mechanism. In addition, a further rate cut would, in our view, tease up inflation risks more than it would support growth on a sustained basis. As such, we see limited room for additional rate cuts, a total of 50bps over the next one year. Bottomline: The RBI surprised market by staying on hold, but made the right decisions. The slowdown is to a large extent driven by supply-side constraints, which explains why inflation has remained elevated. Going ahead, the room for rate cuts is limited, and policy efforts should focus more on deeper rooted structural reforms to boost growth. Source: RBI/HSBC Global Research/Bloomberg

5 Macroeconomic Overview India Inflation remains high Facts Inflation has come down from its highs last year, but this has partly been on the back of a washing-out of food price base effects. During the past few months inflation has remained remarkably stable, and it even ticked up in May: Headline: WPI inflation came in at 7.55% y-o-y in May (versus 7.2% in April), which was above consensus (7.5%) and our call of 7.3%. Core: Non-core: Core inflation (non-food manufacturing) rose slightly to 4.7% y-o-y (versus 4.6% y-o-y in April). Primary food price inflation rose marginally (10.7% y-o-y versus 10.5% in April). Prices of non-food primary articles rose notably 8.5% y-o-y (versus 1.6% in April) and inflation for fuel & power also ticked up (11.5% versus 11.0% in April). Implications This was not exactly a very encouraging inflation number for the RBI. Food inflation base effects are washing out and food prices are also picking up in sequential terms, which could have implications for inflation expectations and, consequently, the level and persistence of inflation more generally. While core inflation stayed below 5%, it could begin to rise again as the second-order impact from rising food and fuel prices filter through, the latter in response to hikes in diesel and kerosene prices needed to contain the fiscal deficit. Moreover, the sequential pick-up in both headline and core inflation suggests that inflation pressures remain strong, and it would be premature to conclude that core inflation is on a sustained downward trajectory. There are also upside risks to core inflation from the still-tight capacity prevailing despite the slowdown in growth. Given the above, whilst room for interest rate cuts look limited despite the slow-down in global/domestic growth, the RBI will, in our view, likely continue to manage liquidity conditions actively through open-market operations to contain the liquidity deficit. However, the liquidity deficit has eased significantly since earlier in the year in response to the unwinding of seasonal factors (such as advance tax payments) as well as the deep cuts in the CRR (125bp) and significant open-market operations (OMOs). That being said, additional OMOs and CRR cuts cannot be ruled out. Bottomline Inflation as well as liquidity deficit in the system remain high with limited room for RBI to cut rates. Further rate cuts would, in our view, tease up inflation risks more than it would support growth on a sustained basis. That being said, additional OMOs and CRR cuts cannot be ruled out. Source: RBI/HSBC Global Research/Bloomberg

6 Macroeconomic Overview India We scale back our India GDP growth fore-casts In light of the weaker starting point for the year, the slower progress on supply-side reforms than previously expected and the more protracted global economic recovery, we scale back our India GDP growth forecasts notably. For FY2013, we now expect growth of just 6.2% (versus 7.5% previously) and for FY2014, we believe it will recover to around 7.4% (versus 8.2% previously). In terms of growth profile, annual and sequential growth will remain quite moderate in the coming quarters, and we only see scope for a gradual recovery in growth during the second half of the fiscal year on the back of a stabilization of global economic conditions and a bit more traction on structural reforms. However, there are still downside risks to this outcome. From the external side, a further worsening of the debt crisis in Europe would naturally have implications and the room to counter adverse economic spillovers will be less this time given the persistent nature of inflation and the wider fiscal deficit. From the domestic side, the key risk to the outlook is that policy paralysis persists, which will limit the scope for a recovery as it leaves the potential growth rate stuck at %. Source: RBI/HSBC Global Research/Bloomberg

7 June Recap India - Equity Equities bounced back in June on the back of the risk on beta rally primarily on account of receding concerns of a Euro-zone breakup. Domestically, the government has issued clarifications on issues such as GAAR, retrospective taxation as well as other economic reforms which have revived the hopes of an end to the policy paralysis. YTD June 2012, FIIs have brought in a total of USD 8.3Bn into the Indian markets (as compared to outflow of USD 0.4Bn for YTD June 2011), though for the month of June 2012, the FIIs witnessed an outflow of USD 86Mn. India - Fixed Income The longer end of the yield curve rallied during the month due to the issuance of a new 10 year benchmark, with yield which was better than market expectations and on the RBI continuing its buy back of bonds programme (OMOs). The RBI in its monetary policy review left policy rates unchanged as against market expectations of a cut, this in turn lead to volatility both at the shorter and longer end of the yield curve. Currency Concerns over slowing domestic growth, the fiscal and current account deficits, sticky inflation along with policy inaction caused the INR to touch an all time low of against the USD in June. This was despite various measures announced by the RBI during the month to support the INR by attracting more foreign investors into the local bond market. USD weakened against the EUR and GBP during the month due to a risk on rally due to a stable election outcome in Greece and on the Federal Reserve increasing its quantitative easing programme through Operation Twist. Commodities Oil prices eased during the month on concerns over slowing global growth. Gold prices appreciated during the month due to a weaker USD and easy monetary policies. Equity - India MTD YTD Sensex 17, % 12.8% CNX Mid-cap 7, % 20.3% Equity - World MSCI Emg Mkt % 2.3% MSCI World 1, % 4.5% Bonds & Currency 10 Yr Yield INR 8.18% 31 bps 38 bps INR/USD % 4.8% Commodities Gold (USD) % 2.2% Brent Crude (USD) % 7.1% As on June 30, Source Bloomberg

8 India - Equity Indian markets have recently participated in the global risk on equity rally supported by the easing of Eurozone concerns. Separately, the market sentiments have also been positively impacted by domestic factors, mainly the recent statements from the PM (who has taken over the Finance portfolio) on clarifications on GAAR, possible retraction on retrospective taxation, infrastructure push, and other possible steps to provide a much needed growth impetus to the Indian economy. Some of the other positives which have aided sentiment include correction in global crude oil prices, slowdown in gold imports, recent containment of the INR depreciation and expectation of further interest rate cuts in H2CY12. The above, coupled with the current fair valuation of the Indian equity market, is expected to limit downside, in our view. In the short term however, we expect the markets to remain volatile with an upward bias primarily due to the risk on rally. However in the medium term, once again the focus will shift to sustainable solutions for the Euro zone crisis and on concerns regarding the ability of the Indian Government to control the current account / fiscal deficit and to push for key structural reforms required by the country to boost growth. We remain neutral on the asset class as a whole as equity valuations remain low both in absolute and relative terms, which, along-with the expected easing of the interest rate cycle over the next few months should provide downside support to the market. We expect a positive 2012 finish despite the current slowdown, as the market has corrected significantly since it peaked in November We consider the Sensex to be trading below fair value. We estimate the index to be at 18,700 (old target: 19,300) by year-end 2012 (14.7x FY13e consensus EPS), implying potential upside of 10%. We continue with our selective approach, maintaining a preference for companies and sectors that exhibit earnings resilience backed by strong balance sheet s and corporate governance. PMI reading indicating stable growth, however economy has entered a slow-growth period by Indian standards FII flows slow down post a very strong first quarter Fair valuations may restrict downside Prev. Month = This Month = Nifty volatility index has eased on receding Eurozone concerns Source: Bloomberg; All the views expressed in this document are 12 month views; -ve means negative, = means neutral, +ve means positive

9 India - Fixed Income Bonds at the longer end of the yield curve rallied during the month due to the issuance of a new 10 year sovereign benchmark (8.15% GOI 2022) which was better than market expectations and on the RBI continuing with its Open Market Operations (buy back of bonds) which in turn supported yields. However the gains witnessed at the longer end of the yield curve were capped due to the RBI maintaining a status quo on the interest rates as against market expectations of a rate cut of 25bps -50bps. Easing systemic liquidity along with expectations of rate cuts in Q3CY12 caused the shorter end of the yield curve to ease during the month. We continue to believe that the longer end of the yield curve will remain volatile due to the a) supply overhang (weekly issuances ranging between INR B) b) concerns over the twin deficits (fiscal and current account deficit) and on c) rising subsidies due to sizeable under-recoveries in administered product prices. In view of the inverse yield curve and with supply concerns impacting the longer end of the yield curve, we continue to suggest that investors should remain invested at the shorter end of the yield curve through short term bond funds and FMPs. Selective exposure however maybe undertaken to longer tenure bonds especially the tax free issuances given their high post tax yield, good credit quality and possible gains over the longer term aided by expected reversal in interest rates. Long term aggressive investors may selectively undertake exposure to quality actively managed income funds to take advantage of the volatility. Core inflation within the Wholesale Price Index remained subdued while food led prices rose Systemic liquidity improved during the month on account of government spending along with the RBI conducting buy back of bonds Prev. Month: Duration =; Liquidity =; This Month: Duration =; Liquidity =; Credit growth rose during the month, while deposit growth remained subdued The yield curve ended lower due to improvement in liquidity INR Sovereign Curve Current INR Sovereign Curve Prev Month 3M 6M 1Y 3y 5Y 8Y 10Y 12Y Source: Bloomberg; All the views expressed in this document are 12 month views; -ve means negative, = means neutral, +ve means positive

10 Currencies Prev Month: USD =/+; GPB =/-; EUR =/-; USDJPY = /+; EM =/+ ; INR - This Month: USD =/+; GPB =/-; EUR =/-; USDJPY = /+; EM =/+ ; INR =/- INR touched all time low against the USD in June INR touched all time lows against the USD as it breached levels of 57. Domestic factors like uncertainty in the investment environment and the large fiscal deficit (FY12-5.8% of GDP) are primary concerns facing overseas investments into the Indian market leading to the weakness in the INR. Furthermore, over the last few months, the RBI has not been aggressively intervening in the forex market thereby seeming to allow the INR to weaken, provided it takes place in an orderly manner. It is also constrained in how much it can do, particularly with the ongoing rise in inflationary pressure and relatively low levels of FX reserves. The pain threshold however appears to have been hit with the extent of recent INR weakness in the last month which has spurred the authorities into action. The RBI recently introduced a number of measures including raising the FII limit in sovereign bonds. Despite these measures, we believe that as long as the longer term structural issues facing India are not addressed satisfactorily, the scope for further currency appreciation will be limited. We remain on high alert for regulatory changes by both the RBI and the government. However, if these announcements lack substance, we expect spot INR to weaken back to its high of 57.32, seen in June. USD weakened against the EUR and GBP during the month The US dollar is unlikely to see demand wane significantly as concerns about the Eurozone and the slowdown in global growth keep the safe haven currency well supported. We believe the Euro will remain under pressure for now, although it could find some support if policymakers answer critical Eurozone questions.we maintain our preference for GBP over EUR as it may benefit from a search for diversification by investors. We remain cautious on the short-term outlook for emerging market currencies, although the recent correction is leading to attractive long-term entry points in our view. Source: Bloomberg; All the views expressed in this document are 12 month views; -ve means negative, = means neutral, +ve means positive

11 Commodities Prev Month: Gold =/+; Oil =; Agricultural =; Industrial = This Month: Gold =/+; Oil =; Agricultural =; Industrial = Ongoing worries about Chinese growth and the impact of the Eurozone crisis on global growth are likely to keep demand for commodities muted in the coming months, putting pressure on prices. In addition, a strengthening USD is likely to be an additional headwind for commodities. Gold prices gained during the month Crude oil witnessed selling pressure during the month A strengthening USD and a weakening INR may cause Gold to remain in a trading range in the short term. We believe that a combination of monetary and financial influences, geopolitical concerns, and heightened investor anxiety will spur higher gold prices to move just above USD1,900/oz by the end of Sluggish underlying physical supply/demand balances are likely to keep gold from challenging the USD2,000/oz level, in our view. To the downside, we believe, a break of USD1,500/oz would stimulate increased physical demand and raise the possibility of a reduction in mine output, and this should help set a floor for prices at around USD1,450/oz. In the longer term, accommodative monetary policy by Western central bankers are making the opportunity cost of holding gold negligible. Further, currency diversification should continue to support demand for gold in the long run, which we believe still seems a good alternative to Western currencies, which are seeing their value deflate due to high government debt With tensions in the Middle East having eased somewhat recently, we believe that slower global growth should keep oil prices range bound. In the longer term, we expect oil prices to remain supported by emerging market (EM) demand, but this may take some time to materialise. In our view, industrial metal prices may remain under pressure as global growth slows but over the long run, they should benefit from the more stable longterm Chinese outlook and growth in the emerging markets. The agriculture index gained ~11% during the month The industrial metal index gained during the month We expect agricultural commodities to remain volatile given uncertain weather patterns, although the longer-term trend of growing demand from the emerging markets should provide some support to prices. Source: Bloomberg; All the views expressed in this document are 12 month views; -ve means negative, = means neutral, +ve means positive

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