December 31, 2014

Canara Rebeco. Mutual funds.

Outlook for 2015

Positive developments, on both domestic and global front, augur well for the Indian economy. Falling crude oil and commodity prices have further bolstered external sector stability, while helping in fiscal consolidation and curbing inflation, all of which would help in softening rates and promoting growth in 2015.

There are several triggers which are likely to influence market movements in 2015. The trend in lower inflation resulting in expectations of lower interest rates will help in kick starting the investment cycle. Sustainability of low oil prices and commodity prices will help in bringing down the deficit and further reduce cost for corporate India. Further, the introduction of GST on a time-bound manner should help in improving GDP growth over the next 3 to 5 years.

From a global perspective, the extent of the slowdown in Europe and the actions of various Central Banks around the world will result in ultra low rate regime in place for longer, though this may lead to heightened volatility across financial markets. In addition, timing of interest rate increases in the U.S. would be critical in determining flows towards emerging markets including India.

Market Performance

The domestic equity markets represented by the benchmarks CNX Nifty and S&P BSE Sensex were volatile during the month, to close at 8282.7 and 27499.4 respectively on 31ST December 2014. The CNX Nifty gained 31.39% while the BSE Sensex rose 29.89% in the Calendar year 2014 (Data Source: NSE, BSE).

Inflation continues trending down

The latest wholesale inflation print (WIP)comes at a time when India's factory output contracted unexpectedly in October for the first time in seven months and in its worst performance in three years, while retail inflation touched a new low since the series was launched in 2012. Though the central bank now focuses solely on retail inflation, a 0% WPI inflation will add to the clamour for an interest rate cut to spur consumer demand and investment. India's wholesale inflation fell to zero in November, lowest since the post financial crisis deflation in July 2009, following dramatic fall in fuel and food prices, cementing expectations of an early interest rate cut by the Reserve Bank of India (RBI) to stimulate the struggling economy. WPI-based inflation was last in the negative territory in the three months from June to August in 2009.


India's industrial output saw the sharpest decline in the last two years and contracted by 4.2% in October 2014,dragged down by a fall in the manufacturing and the capital goods sector. Industrial production was upwardly revised to 2.8% year-on-year in September 2014 from 2.5%. The cumulative growth for the period April-October 2014-15 over the corresponding period of the previous year stood at 1.9% as against 0.2% in same period of last fiscal.

Trade Deficit

During April-November 2014, imports were up 4.65% to $316.37 billion, while exports were up 5.02% to $215.75 billion. Trade deficit during this period stood at $100.61 billion. India's trade deficit widened to one-and-a-half year high of $16.86 billion in November 2014 due to over six-fold jump in gold imports even as merchandise exports grew by 7.27%. Trade deficit in November last year was $9.57 billion. Total imports in November 2014, including oil, jumped by 26.79% to $42.82 billion. Besides the precious metal, higher imports of transport goods, fertilizer, machinery and electronic goods added to the trade gap which rose to its highest level since May 2013.


Brent crude, which has hit a four-year low, is a big boon for the Indian economy. Falling crude prices will further narrow current account deficit and support the rupee. Subsidies will come down, leaving more funds for productive investment. While India took corrective actions to ensure a smooth supply of crude oil, it remains exposed on the price front. If an uptick is seen in oil prices, it is likely have a negative impact on India's outlook for inflation and the current account deficit, as well as hurt the rupee. However, the current supply glut and low demand in oil coupled with fight for market share by oil producing countries is likely to keep oil prices capped in the near future.

India registered the best GDP growth in nine quarters between April and June, 2014. If the momentum continues, the Indian economy is likely to return to the 7-8 per cent growth path within a few years.

The next big focus is on the timing of a US rate hike. FED policy, going forward, will be an important trigger for global markets and liquidity flow.

Interest rate cuts will be next big trigger for markets. A continued softening of inflation can help RBI to shift focus to growth and thereby make the monetary policy more accommodative. A benign rate regime is likely to push corporates to start investing, leading to higher productivity for the economy. Rate cuts will also incentivize consumers to spend more, leading to higher spending and productivity. Moreover, a drop in inflation may shift focus from savings via hard assets (like real estate, gold etc.) to financial assets, thereby further helping in revival of the investment cycle.

Global events, notably US dollar strength, QE by the ECB and low commodity prices especially crude oil will likely continue to influence market sentiment and drive global fund flow. Improved macro climate and political stability in India makes it standout in the EM space, with commodity dependent countries like Brazil and Russia facing significant challenges. India is likely to garner a larger share of EM flows in 2015

Source: MOSPI

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India's bellwether index S&P BSE Sensex rose by around ~30%* in CY 2014 making it one of the best years for Indian Equity markets. The year also saw the market capitalisation of listed companies on the BSE surpass Rs 100 trillion~. However contrary to the general trend the month of December closed in red on back of uncertainty in global markets & weak domestic indicators like IIP & Rupee. Nevertheless the long term view for the asset class continues to remain positive.

Market Performance*

India's benchmark indices S&P BSE Sensex & CNX Nifty rose by 29.89% & 31.39% respectively for CY2014. Mid- and small-cap indices outperformed their larger peers. The S&P BSE Mid-cap index gained 54.69% and the S&P BSE Small-cap index gained 69.24%.

The month of December'14 saw S&P BSE Sensex falling by 4.16% to close at 27,499.42. CNX Nifty too recorded a decline of -3.56% to close at 8282.70. Meanwhile, S&P BSE Mid-Cap gained 0.99% while 3.33% and S&P BSE Small-Cap index fell by 1.63%.


India's manufacturing sector represented by HSBC Manufacturing PMI came at 53.3 in November'14 from 51.6 in the previous month aided by stronger growth of output and new work orders. However, cost inflationary pressures intensified during the month providing a note of caution to the growth outlook.

The HSBC India Services PMI climbed to a five-month high of 52.6 in November'14 supported by an uptick in order flows. Among the broad areas monitored Post & Telecommunications was the best performing while Financial Intermediation and Hotels & Restaurants recorded contraction.

Contraction in IIP^

After better-than-expected recovery in industrial production in the month of September'14 the sharp contraction in IIP in October'14 discouraged market sentiments.

Index of Industrial Production (IIP) contracted by 4.2% (y-o-y) for October'14 viz. 2.8% (y-o-y) (revised) growth in the previous month. Sector-wise mining & electricity recorded a rise of 5.2% & 13.3% respectively while manufacturing recorded a de-growth of 7.6%. On the use-based side only basic goods came in positive recording a growth of 5.8% while the rest registered a contraction. Capital goods contracted by 2.3% & intermediate goods recorded a de-growth of 3.1%. The consumption basket on the whole contracted by 18.6%, imposing a considerable drag on IIP.

Trade Deficit Narrowed#

India's trade widened in November '14 to USD 16.86 billion from USD 13.36 billion in the previous month as Gold import rose to USD 5.61 billion. Further import demand for machinery & transport equipment increased by 40% (m-o-m). The increase in demand for machinery and transport equipment combined with 7.27% (y-o-y) rise in exports supports the view that the Indian economy is slowly reviving.

Going forward, the decision of OPEC nations against cutting oil production is likely to keep the oil prices at the current low levels. However at the current level of oil prices the profitability for several oil producing nations is coming under pressure raising concerns regarding sustainability of this trend. On export front recovery in US as well as any export oriented policies by the Government may augur well for exports however deflationary environment in Europe may be negative for exports.


The month of December'14 saw extreme volatility in equity market on account of steep contraction in October'14 IIP numbers, weak rupee & global uncertainty surrounding oil prices. The month also recorded some FII outflows from the equity markets however FOMC commentary to remain patient while increasing interest rates, calmed the global market. It is expected that US FED is likely to hike rates in 2HCY15. In the near term domestic market will focus on 3QFY15 results and the budget session in the month of Feb15.

The clearance of Goods & Services Tax (GST) by cabinet is a positive first step towards implementation of GST which has been delayed for a long time. GST is likely to be positive for both the organized players in the manufacturing sector as well as the Government. It is likely to decrease the total tax incidence on organized sector players further by bringing both organized & unorganized players under one umbrella of taxes is expected to reduce the competitive advantage of the unorganized players. The increase in tax base due to GST will be positive for the Government.

The Government collected around 1,700 Cr. through divestment in SAIL. Going forward we are likely to see stake sale by the Government in other PSU's like ONGC, Coal India etc. This may help to bring retail participation in the equity markets as well as it will help to decrease fiscal deficit.

2015 is likely to be an important milestone for the Indian economy as India is heading towards a period of sustainable growth & conducive macroeconomic scenario. We expect the corporate earnings to improve in coming year. We believe India is in a structural bull run; there will be corrections on the way, however a staggered exposure to equities may help even out market volatility.


1. Rate – cut by RBI: A rate – cut by RBI would signal RBI's belief that the inflation is within the Central Bank's comfort zone & this would be viewed positively by market participants.

2. A decision by OPEC nations to decrease oil production to shore – up the price: This may be detrimental to India on two fronts: First it is likely to increase inflationary pressure on the economy & second it is likely to have a negative impact on the current account deficit.

*Bloomberg &
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RBI policy : preparing for rate cuts

The RBI's tone shifted from hawkish to dovish with RBI hinting that policy easing may start in early 2015. We expect the RBI to cut rates in March 2015 only after factoring in (1) the Union Budget in end-February 2015 and (2) clarity on the disinflationary impulses after the base effects diminish.

Headline CPI inflation decelerated further

CPI inflation decelerated to 4.4% in November 2014 from 5.5% in Oct-14 and 11.2% in November 2013. This was largely in line with market expectation of 4.4%. While a high base effect from last year was expected to lower inflation, the monthly sequential momentum has also been decelerating since Aug led by both food and non food categories.

Slow credit growth in 2014

The year 2014 saw loan growth coming down to 10.8 per cent compared to 14.9 per cent during the same period last year, according to latest data available. According to Bloomberg data, 1997 was the year when credit growth fared worst in the last 18 years by growing at 9.94 per cent. High interest rate, policy uncertainty in the year of elections, along with risk aversion led to slow takeoff in credit demand on the corporate front. On the retail front also, loan takeoff hasn't been encouraging. During the festival season this year, car sales dropped whereas housing inventory shot up, signalling poor demand.

Liquidity tightened towards quarter end

The liquidity deficit as measured by Liquidity adjustment facility (LAF), Marginal Standing Facility (MSF) and the Standing Liquidity Facility availed from RBI added together was at Rs. 1,21,501 crore as on 30th December, 2014,’14 compared to Rs.60,314 crore as on 29th November, 2014. Liquidity situation tightened towards the quarter end due to outflow from banking system on account of advance tax and other quarter end requirements by corporate.

Credit ratio improving

Corporate India's credit quality is showing early signs of recovery, as indicated by CRISIL's credit ratio (ratio of number of upgrades to number of downgrades) of 1.64 times for the first half (H1) of 2014-15 (refers to financial year, April 1 to March 31),2014-2015. Upgrades exceeded downgrades in H1 2014-15, with 741 upgrades as compared to 451 downgrades. Firms with low debt exposure primarily witnessed positive trends in credit quality.


RBI's inflation target is set at 6% for January 2016 and with inflation drivers looking weak, this looks to be achievable with enough room to spare. In its guidance RBI hinted that there will be room for easing in early 2015 if inflation trend continues and government fiscal developments are positive. We expect rate easing cycle to start in 2015, and as inflation continues to trend down, there are likely to be multiple rate cuts in next fiscal year. With sharp drop in oil prices, inflation is likely to remain subdued in 2015, giving RBI ample room to ease policy rates. We expect the RBI to cut benchmark interest rates by 50 - 75 bps in 2015, starting in 1QCY2015.

With this backdrop, a growth recovery, which has been anemic so far, would likely pick up into 2H FY16. Market has already discounted some part of rate cut by RBI in early part of CY2015, with the 10Y breaking below 8% and touching 7.98%. We expect yields to continue its downward trend over the next few years. Investors can look to increase allocation to fixed income funds, from medium to long term perspective, depending on their respective risk profiles.

Crisil Research

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