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28 Nov 2020

Election results and outlook on Sensex, Nifty 10-Yr-G-sec,INR

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Equity markets will stabilize at higher levels and take direction from earnings outlook, economy and global issues.

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Arjun Parthasarathy

Equity markets will stabilize at higher levels and take direction from earnings outlook, economy and global issues.

Equity markets have a lot of headwinds despite political risk going out of the market. The government has to continue with reforms and take sustained measures to revive the consumption economy. which is a continuous work in progress. Valuations have dropped and are dropping further, which gives good entry levels for fundamentally strong, long term consumption driven growth stocks.

The markets are trading at record highs despite weaker incoming economic data both on the global and domestic front. On the global front, China and Eurozone PMI has weakened while in the US, industrial output witnessed  decline. Ongoing, US – China trade has intensified after US President Donald Trump announced additional tariffs on Chinese imports and increasing concerns regarding a conflict escalation in the Middle East have impacted overall global market sentiment.

Indian equity markets are also witnessing challenging environment as trade-deficit widened and IIP growth fell. The 4th quarter Fy 19 results and management guidance point to a slowdown in demand and headwinds are there across many sectors. The NBFC liquidity crisis is also weighing on financial sector, consumption sector and infrastructure sector. Auto sector is  witnessing  slowdown and gloomy projection for consumption ties in with that for automobile sales, together painting a bleak picture of the Indian economy. However,  the government is expected to increase infra-spending during this fiscal year and RBI might also cut rates in order to spur growth. During interim budget session, government had focused on rural spending for this fiscal year. Uptick in rural demand and expansionary monetary policy should bring back economic growth, which will have a positive ripple effect on corporate earnings going ahead.

Click here to read our analysis on Q4Fy19 result trends.

On an overall basis, economies are on a much stronger footing than what they were post the 2008 financial crisis, which spurred an unprecedented central bank accommodation. Unemployment rate is down sharply from highs, economies are growing, and inflation has stayed down (which leaves some space for global central banks to cut rates). In the wake of weaker incoming economic data, central banks that were turning neutral are now rethinking their stance. Short-term outlook for markets will be consolidating but longer term outlook for markets is more promising given that both global and domestic economy is nowhere close to the bubble levels seen pre – 2008 financial crisis.

INR Outlook

INR will stabilize at higher levels but direction will come from global issues of trade wars, central bank policies and geo politics.

INR surged against USD by more than a percentage point on Monday amid optimism that the BJP-led NDA will be able to form the government at the center for a second term. A strong political standing for the ruling party would ensure continuity in economic reforms and will be a big positive for economic growth and revival and will help INR to consolidate at these levels.

INR has been falling in the recent weeks on the back of firming up of crude prices and not so very favorable prediction on Monsoon rains in India.

The sentiment has been fragile as foreign funds have pulled out more than USD 568 million combined from domestic shares and bonds this month amid political uncertainty and the risk off mood triggered by the U.S.-China trade standoff. Additionally, INR came under pressure after data showed that India’s trade deficit widened to a five-month high in April due to rise in crude oil imports coupled with muted growth in exports.

Fixed Income Outlook

Bond yields will trend down on rate cut expectations and on RBI OMO bond purchases but the yield curve will steepen on supply hitting markets. Short end of the curve will see drop in yields while 10 year government bond will consolidate once the volatility subsides.

Credit spreads will stay wide until credit issues are sorted out, which will take at least one quarter.

As the Loksabha election 2019 results trends indicates status quo at Central government we do not see any structural changes at policy levels.The government is expected to stick to projected levels at fiscal deficit of 3.4% of GDP for the fiscal year 2019-20 from a similar fiscal deficit  for the fiscal year 2018-19 (Revised Estimate from 3.3% of GDP) .

The Indian Economy is going through a rough period with multiple uncertainties. The key growth driver of the economy, the fast-growing consumer economy, is showing weakness in demand, especially on the rural side. Investment demand is yet to pick up and election uncertainty is postponing investments. Bad loan issues for banks continue while NBFCs are facing a liquidity freeze. hurting credit to consumers.

The spread between the 10 year benchmark government bond the 7.26% 2029 bond and the benchmark 5 year government bond the 7.32% 2024 bond has widened from 8bps to 22bps in the last few days, indicating that markets are buying into the short end of the curve bond in anticipation of RBI rate cut in its June policy review. 1 year and 5 year OIS yields too have fallen sharply on rate cut expectations.

Post RBI April policy, bond yields and OIS yields rose, as RBI maintained a neutral policy stance and markets expected that more rate cuts may not happen. However, given weak economic data, rate cut expectations have risen sharply.

Trade data is showing weak export growth on global economic uncertainty brought about by US-China trade wars. The rural economy is showing weakness on low prices of farm produce, CPI inflation is below RBI target of 4% while core CPI inflation has come off from highs of 6% to levels of 4.5% over the last one year.

Liquidity is in structural deficit despite RBI adding Rs 3 trillion of primary liquidity through OMOs in the last fiscal year. Cost of credit has risen despite RBI rate cuts with credit spreads rising over the last six months post IL&FS default. The 10 year government bond spread over the repo rate has risen sharply from lows seen a couple of year ago. Rate cuts are not filtering through and real interest rates have risen if measured by spread between CPI and repo rate.

The 4th quarter fy 19 results and guidance from companies such as Maruti and HUL indicate a consumption slowdown and guidance given by these companies is muted. Demand slowdown is hurting corporate earnings and this could worsen any investment demand. Banks both Public and Private Sector Banks are showing rising provisions for bad loans on new RBI norms and fresh slippages and this is likely to continue to for the next couple of quarters. Weakening corporate earnings is adding to concerns on bad loans and credit growth will be affected.

The real estate sector is going through a tough phase with lack of demand and lack of credit and this is leading to more NPA worries for banks from this sector.

The government is fiscally constrained to spend given record borrowings for fiscal 2019-20 and with bank deposits growing at below double digit levels, the absorption of supply is in doubt.

In all this, RBI maintained a neutral policy stance in its April policy despite lowering the repo rate to 6%. RBI has to now consider changing its stance and adopt a more aggressive approach to rates and cut the rates sharply in June to prevent the economy from going down further.

On the global front, US economic data is strong and with Fed adopting a wait and watch approach to rate hikes, the economy can stay strong. Data from Eurozone came in marginally better and ECB is maintaining record low rate policy and adding liquidity through LTROs.  (Long Term Refinance Operations). China saw weakness in data and is fiscally and monetarily pump priming the economy in the face of trade wars while Japan data came in better and BOJ is ultra loose on policy. Inflation remains low across the globe.

Liquidity

Fiscal 2018-19 saw extreme tightness in liquidity on the back of RBI fx sales, rise in currency in circulation and high incremental credit deposit ratio. RBI had to buy bonds aggressively through OMOs to infuse liquidity into the system.

Fiscal 2019-20 looks to be an easier year for liquidity given dovish global central banks, which is placing less pressure on the INR. RBI liquidity infusion is likely to continue until liquidity eases, which will in turn help banks fund credit growth. Currency in circulation will not see any abnormal movements post elections, given low levels of inflation, projected at below 4% for the first half of the year.

RBI has bought Rs 2.98 trillion of bonds through OMOs in fiscal year 2018-19. A large amount of liquidity was sucked out of the system through RBI forex sales of USD 24.78 billion, which is equivalent to Rs 1.76 trillion. Banks ICDR (Incremental Credit Deposit Ratio) running at over 100% is adding to the liquidity crunch and rise in currency in circulation by Rs 2.3 trillion has sucked out liquidity from the system.

India Credit Markets 

Credit markets continue to be in a liquidity freeze and the market is hoping for a strong policy responses from goverment. The market is in fear of downgrades and defaults and there is no secondary and primary liquidity for any security or issuer apart from a few.

OIS 1-year & OIS 5-year Movement

India Core CPI & CPI Inflation

CPI Inflation - Repo Rate

USD INR - 1 Year Movement

Brent Crude Oil Prices

Monthly FII Net Investments (INR billion)

India's Foreign Exchange Reserves (USD Billion)

3 year AAA Spreads

 

Disclaimer:

Information herein is believed to be reliable but Arjun Parthasarathy Editor: INRBONDS.com does not warrant its completeness or accuracy. Opinions and estimates are subject to change without notice. This information is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The financial markets are inherently risky and it is assumed that those who trade these markets are fully aware of the risk of real loss involved. Unauthorized copying, distribution or sale of this publication is strictly prohibited. The author(s) of the content published in the site INRBONDS.com may or may not have investments in the assets discussed in the pages/posts.

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