The BSE Sensex and Nifty 50 Index were down 1.7% and 1.3% respectively in January as the market saw a large sell-off due to the US killing of Iran's top military commander, but the markets subsequently bounced back after both countries quickly moved away from a wider military conflict. The phase one agreement between US and China, the Supreme Court’s dismissal of the telcos’ review petitions on the AGR case, rising concerns over the fast-spreading coronavirus were the other key developments in the month, which kept the large cap indices under pressure. India’s broader market, however, did well, with both mid cap and small cap indices sharply outperforming their large cap peers. In terms of India’s domestic economic activity indicators, barring consumer credit growth, most other indicators like auto sales (wholesale), consumer durable production continues to remain weak. FIIs (Foreign Institutional Investors) were net buyers to the tune of $1.4bn in January whereas DIIs (Domestic Institutional Investors) were net buyers of $0.3bn. DMFs (Domestic Mutual Funds) were net buyers of $0.2bn whereas Domestic Insurance companies bought $0.1bn during Jan. Deal momentum slowed in Jan with just 2 deals but the total size was healthy at ~$2.2bn (vs 7 deals worth ~$1.5bn in Nov). Among sectoral trends, Realty (+10.8%), Consumer Durables (+4.5%), Healthcare (+3.9%), Cap Goods (3.1%) and IT (+3.1%) were the best performing sectors during the month whereas Metals (-9%), Oil & Gas (-5.6%) and Bankex (-3.8%) were the worst performing sectors.

Union Budget – 2020-21 - Key Highlights:

The Union Budget 2020-21 was presented on 1st Feb’20 amidst a challenging economic environment. The FY2021 union budget presented a mix of modestly higher spending, lower personal income taxes (under an alternative personal taxation regime) and abolishment of dividend distribution tax (DDT) to revive the economy. It also spelled out key areas of future reforms that can reinvigorate private investment as well as continue on its path of divestment. While the Govt. did take the liberty to relax the fiscal deficit by 0.5% v/s earlier budgeted for the current year, it kept to its overall fiscal discipline and eschewed going down the path of providing any strong fiscal stimulus. The central government has projected a fiscal deficit target of 3.5% for FY2021 v/s 3.8% for the current year, which looks reasonable. The immediate reaction of the market post budget however, was sharply negative, on the disappointment of not having seen strong measures to stimulate demand.

On balance, the budget appears to be an overall effort to steady the economy through a good mix of cyclical and structural factors. Our outlook is still for a modest cyclical economic recovery over the next 12-18 months led by moderately better global growth, steady domestic/global liquidity and probable incremental rural tailwinds; much of these did not have lot to do with the budget anyways. The adverse market reaction only gives investors another opportunity to buy decent businesses as they turn more attractive on valuations. If any of the seemingly unrealistic elements such as disinvestment proposals or improved consumption through personal tax rationalisation and resultant improvement in indirect tax (GST) collections, not to mention the probable settling down of coronavirus work out, they will provide the surprise element to the market. Moreover, if any part of salaried class opts for the new tax option, it will mean more net take home post tax and thus more flexibility around their investment planning.

We think conditions for a modest domestic economic recovery helped by a confluence of global and domestic factors is developing, which in turn should likely broad base the market in terms of investment options. This augurs well for midcap/small cap investing and is already evident in the narrowing of the performance gap between the large and mid/small indices over the past 3-6 months. We expect the trend to further strengthen in favour of mid/small caps during the course of 2020. While we do take a more constructive stance on the economy and markets as a whole, we remain measured in our conduct with regard to portfolio choices. We keep our growth expectations measured while simultaneously increasing the bar on quality of businesses and balance sheets that attract us.

The bond prices had a downward pressure over the month of January’20. While RBI did conduct several operation twists over the previous 2 months (in order to soften the yields of long bonds) the effect of operation twist on the shape of the yield curve was slowing ebbing.

Over the previous month, the prices fell due to the following 2 reasons:

• Fears of fiscal slippage in FY20 and moving away from the FRBM (Fiscal Responsibility and Budget Management) target path of 3% for FY21
• The sudden spike in the onion prices leading to a sharp rise in the CPI headline to 7.35% for Dec’19. This jump in the inflation data deserted expectations of any more rate reductions in the near future despite the slowing GDP growth.

The negative sentiment was acute, and the 10 year benchmark yield moved northwards by about 15bps from 6.50% in Dec’19 before closing at 6.60% at Jan’20 end.

The rally in global bond yields post emergence of the news about the coronavirus affecting the growth in multiple regions across the globe helped in softening the domestics yields in the last week of Jan’20.

The annual budget placed in the parliament on Feb 1st assuaged the fears of additional borrowing in FY20 (due to fiscal slippage) although the fiscal deficit moved from 3.30% to 3.80%. The market borrowings in FY21 was also lower than market expectations, although the fiscal deficit target was revised upwards from 3.0% to 3.50%. FM invoked the ‘escape clause’ available in the FRBM act to deviate from the path by a maximum of 50bps during periods of steep fall in growth or structural changes in the economy.

Strong net positive foreign flows helped in building India’s foreign exchange reserves. RBI’s intervention in the currency market has built up the forex reserves and now stands at a historical high of $ 467 bn. The dollar purchases by RBI ensured that the rupee didn’t appreciate sharply and also enabled injection of liquidity to the tune of Rs. 2-3 trillion over the last 6-7 months. The excess liquidity has been slowly building up from June’19 onwards. However, absence of any risk appetite amongst the bankers has failed to reallocate this excess liquidity into any other form of lending nor helped in pricing the lending at a cheaper rate. The transmission of lower rates into the economy has got halted due to the absence of risk appetite amongst the bankers.

While there has been a substantial jump in the headline CPI the core inflation (CPI ex fuel and food) remains under 4% indicating the demand destruction that has happened within the economy.

Recently in early Feb’19 the status quo decision on repo rate by the MPC members were on expected lines. However, the long-term repo operations (LTRO) for improving monetary transmission is being viewed as a much-awaited definite step to finally ensure some decent quantum of trans1mission in the near future.

Outlook

We are broadly in agreement in the direction of the CPI projections of RBI. However, we feel incase the present trend of the vegetable prices to normalize our projections are lower than the RBI’s forecast by about 20-50bps at various points of CY20.

The statement in the policy document about ‘policy space available for future action’ is being viewed positively by the market participants as potential rate reductions in CY20 as growth remains soft and CPI headline moves southwards from Q3FY21.

The message in the policy document and the media interview of Governor Das later suggests focused attention by RBI towards ensuring transmission of policy rates into the economy and also ensuring that banks are able to price loans at a cheaper rate.

The LTRO is a targeted effort to ensure availability of liquidity for a period of 1 year and 3 years for upto a total amount of Rs. 1 lakh crore at the repo rate is being viewed as a powerful tool being used by RBI, to ensure that the transmission eventually happens.

The availability of liquidity for long period of 3 years will now first ensure that the yields of sovereign bonds and blue-chip AAA credits move lower in line with the move.

The drop in yields of bonds till the 3 year point ideally should eventually push down yields for long bonds (bonds greater than 3 years maturity) as well. While the decline in the yields of sovereign bonds and AAA bond yields do not ensure transmission of this drop in borrowing cost to credits below AAA, but eventually the banks are expected to move in their commercial interest and price loans and borrowings of other credits at a lower rate.

In this environment, we urge investors to select funds in alignment with their investment horizon and longer depending on their individual risk appetite and of high credit quality.