At the monetary policy meeting held in December, RBI kept the Repo rate unchanged at 8.5%. Consequently the reverse repo rate and the marginal standing facility (MSF) rate remain unchanged at 7.5% and 9.5% respectively. RBI noted that the global economic outlook has worsened significantly and that domestic inflationary pressures were moderating. RBI also noted that the downside risks to growth had increased and that monetary policy actions were likely to reverse the hiking cycle, responding to the risks to growth. Liquidity remained tight in the month of December primarily owing to advance tax outflows for the quarter end. As a response to this, RBI conducted Open Market Operations in government securities market to ease liquidity in the system. Bond yields remained supported throughout the month owing to both these factors. Weak growth data from the domestic front further provided support to the market. The IIP figure for the month of October decelerated significantly to -5.1% as against 2% in September. This was mainly due to contraction in manufacturing and mining activities. The contraction was particularly sharp in capital goods with a y-o-y decline of 25.5%, reinforcing the investment decline story emerging from the GDP numbers. WPI inflation for the month of November was noted lower at 9.11%. The Indian Rupee appreciated to 53.07 against the dollar as on 30 December 2011.
Outlook:
We remain neutral on the bond market and expect the 10 year government security to trade in a range of 8.3-8.6%. We expect inflation to sequentially head southwards from current levels. Continued Open Market Operations (OMO) by the RBI will provide support to the market. However, concerns on fiscal slippage and continued supply of government bonds will keep the upward pressure on yields. Global developments will continue to play a major role in shaping the yield movements. We expect Indian rupee to remain range bound against the dollar.
Equity:
Nifty fell 4.3% for the month of December on the back of elevated domestic concerns. FII bought equities worth $5 mn for the month of December. Domestic institutions were buyers to the tune of $120 mn. The month began on a strong note with positive global cues. However, domestic concerns soon overshadowed the optimism. Continued weakness in the rupee despite a number of steps by the RBI also took a toll on the markets. After taking the bold step of allowing FDI in branded retail, the Government decided to put it in cold storage. Further the cabinet also cleared the food security bill that puts an additional burden on Government finances. This raised further concerns regarding an already deteriorating fiscal deficit. Inflation for the month of November eased but continued to be high at 9.1% yoy. RBI it’s in mid-quarter policy review kept rates unchanged. This too added too the pessimism. Depreciating INR caused IT stocks to out perform. Banks and infrastructure stocks were under performers.
Outlook:
We maintain our neutral view on the markets. With growth concerns exacerbating, RBI is expected to ease monetary policy in the coming months. However, the markets continue to face head winds in terms earnings downgrades and a deteriorating fiscal situation. The Government has recently announced an additional borrowing of Rs400bn for the fiscal end March 12. Further, there is still no clarity on what route the government plans to take to meet its divestment target of Rs400bn. The expectations of further weakness in the rupee could lead to foreign portfolio inflows being muted. Sensex valuations at 14.1x FY12E, which are higher than historical mean is likely to limit the upside. We continue to believe that long India’s long term growth story remains intact and offers great investment opportunities.
