Indian equity markets ended the month at a new high, gaining 4% (Nifty) amid volatile sessions ahead of the Union Budget. The FY2025 Union Budget delivered a prudent balance between capital expenditure, fiscal consolidation and welfarism. The government continued with its focus on spending in core infrastructure areas, while expenditure on certain social welfare schemes was under control. The budget did minor variations on tax rates for individuals, while capital gains taxes were harmonised across asset classes. Overall, the budget has reaffirmed its support for the investment cycle by increasing the allocation towards capital expenditure and have also tried to boost consumption through new initiatives (minor direct tax cuts, employment & skilling linked incentives) without taking a populist route and continuing with the fiscal consolidation roadmap. The budget reinforced the government’s growth orientation and, in the process, reaffirming India as a long-term growth opportunity. Mid-cap and small-cap indices were up 5.8% and 4.5% in the month, respectively. Sector-wise, IT, oil & gas, FMCG were up 13%, 10.5% and 9.5%. Banks, metals and realty indices ended with a minor loss of around 1% each. After being sellers in April, and May, FIIs were buyers in the month of July 2024 to the tune of $3.8bn and DIIs remained net buyers to the tune of $2.8bn.

High-frequency indicators remained heterogenous in July and most showed growth on a YoY basis but weakened in sequential terms (seasonality). GST collection rose to its third-highest level of Rs. 1.82 Trillion; growth improved to 10.3% YoY (8.1% in June), while manufacturing PMI softened to 58.1(58.3 in June). Credit growth (adjusted for HDFC merger) slowed to 14% YoY in July, but the loan-deposit ratio rose to 79.4%. Within auto sales, while two-wheelers rose at a softer pace, passenger vehicles declined on a YoY basis. Services PMI edged down a tad to 60.3, even as it remains above 60 in CYTD24, on the back of a robust trend in new domestic and international orders. Air passenger traffic improved in YoY terms, while it contracted slightly on a sequential basis, while consumer sentiment improved sequentially. Anecdotal commentary suggests nascent signs of recovery in rural demand and private capex, ensuring that growth is more broad-based.

Ongoing Q1FY25 result season: Earnings season has started on a muted note. So far, 28 companies from Nifty & 184 from BSE 500 have reported earnings, with Revenue/EBITDA/PAT growth of 8%/4%/2% & 10%/4%/3%, respectively. These figures are fairly lower vs EBITDA/PAT growth of ~20% on avg. for Nifty/BSE 500 in the last 4 quarters. Within the Nifty pack, positive earnings from Banks/ Autos (+20% PAT) were offset by fall in Metals/Energy (>30% PAT decline). Within Nifty, ~30% of the companies missed estimates, while only 20% exceeded them. While the slowing is in line with expectations, this trend will be the most important monitorable over the coming quarters.

Indian markets have digested important domestic events such as the general elections and the budget with ease. Alongside, the impressive progress of the monsoon during July also has added confidence to the overall growth outlook, particularly coming from the rural centres of India. However, global events such as the US elections, the US economic data trends and the direction of global interest rates will likely dominate market attention in the coming months. As we write, the interest rate hike in Japan, early indications of a slowing US economy and geopolitical worries in the Middle East have unnerved markets worldwide. These and their implications for global and domestic growth need to be watched over the coming quarters. Given the strong market performance of the past two years and somewhat stiff valuations, market returns may be more modest for the remainder of 2024. As outlined in our communication last month, the busy event calendar will likely induce volatility and curtail returns in the near future.

We however like India’s current aggregate positioning in the global economic cycle and remain convinced of a strong domestic investment and consumption opportunity unfolding over the next few years. This will provide adequate compounding investment opportunities for investors. Intermittent corrections, particularly those caused by global factors should be used to enhance overall return outcomes.

US Treasury yields declined sharply by 40-45 basis points, and the 10 year Treasury yield moved towards 4% as the incoming benign data on job market, economy, and inflation increased the likelihood of rate cuts in CY2024. In its July meeting, the U.S. Federal Open Market Committee (FOMC) hinted at a potential rate cut in its September 2024 policy meeting.

Domestic G-sec yields rallied across the curve. The much awaited FY25 budget came out to be better than expected as the Govt budgeted lower fiscal deficit of 4.9% for FY25 and further to below 4.5% in FY26. The G-sec yield curve steepened sharply as securities up to 10 years rallied by 10-15 basis points, driven by a reduction in T-bill supply for FY25. The RBI’s proposed Liquidity Coverage Ratio (LCR) for banks also triggered a rally in short end on expectations of higher demand of short tenor G-Sec by banks to meet LCR requirements. Corporate bonds underperformed G-secs, particularly in the short end, and the corporate bond yield curve remains inverted. Domestic banking liquidity turned surplus on the back of Government spending.

Outlook

The global monetary policy backdrop has turned favorable as major central banks have already commenced their rate cut cycles. Recent weak US jobs market data has nearly cemented the September rate cut and the market is now pricing in more aggressive US rate cuts in CY2024. However, global volatility in financial assets may remain elevated on the back of political risks across various countries, especially US as it gets into presidential election.

RBI in its August policy maintained a status quo on policy rates & stance with split 4:2 vote, maintaining its caution on domestic food inflation. Global commodity prices have declined by 10% - 20% from their recent highs and bodes well for global inflation trajectory. However, domestic inflation continues to remain elevated on high food prices. Even as the monsoon has picked up well, headline inflation may remain above the targeted 4% even till 1QFY26. We believe that RBI will be able to get better clarity by CY 2024 end in terms of monsoon and the domestic food inflation and if the global uncertainties recede by then, MPC may look to pivot towards the commencement of rate cut cycle.

Even as domestic rate cut cycle is sometime away, current fiscal year’s budget and associated economic indicators signal a favorable outlook for the Indian bond market. Budget FY25 has proved to be quite positive for both the short end as well as the long end of yield curve. Good for short end of the yield curve as the Budget has estimated a net negative supply of T-bill of Rs. 50,000 crore, thereby reducing the supply in short end. Government has budgeted to draw down Rs 1.37 lakh crore from its cash balance which will help in releasing banking liquidity. Budget also supports long end of the yield curve as Finance Minister has clearly laid out a fiscal consolidation path over next few years. While the Government had much more room to reduce the dated G-sec borrowing in FY25, they have prudently opted for a lower reduction given the huge G-sec FPI demand from JP Morgan Debt index inclusion this year. Demand supply was already favorable in FY25 on the back of JP Morgan debt index inclusion and domestic demand. Longer end demand gets further boost now with higher expected mobilization in NPS / EPFO which normally invests at the longer end. With this budget, even FY26 seems comfortably placed on demand – supply dynamics.

Overall, risk-reward remains favorable at current juncture with benign fundamental & elevated yields across the yield curve. Short end of the yield curve is expected to see a downward movement over next couple of months with improving banking liquidity. Longer end of the yield curve is expected to remain supported on the back of favorable demand-supply dynamics. Any uptick in yields due to still evolving global factors and unfolding political landscape should be seen as an opportunity to build further exposure as the rate cut cycle commensurate over next few months.