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Fund Managers Commentary

December 31, 2011

Equity Market

The European debt crises caused markets to fall in the first half of the month, only to give a mild rally latter in the month on announcement by the European Central Bank of unlimited concessional finance to banks across the Euro Zone. For the month, the BSE Sensex closed down 4.1% at 15,455 while the Nifty closed down 4.3% at 4624. Reflecting the sentiment, large caps outperformed mid and small cap companies in a falling market by a wide margin. In terms of sector performance, auto, fast moving consumer goods, healthcare and software outperformed the Sensex, while the large majority of the sectors like banks, capital goods, consumer durables, metal, oil & gas, power, psu and realty underperformed. FIIs were net buyers of USD 31 mn (net sellers of USD 787 mn in November '11), while mutual funds bought a net amount of USD 107 million (net buyers of USD 150 mn in November '11).

In economic data flow, the Index of Industrial Production (IIP) reported a de-growth of 5.1% YoY for the month of October '11 (2% YoY growth for previous month). On a sectoral basis, for the period April to October '11, both mining and manufacturing have fared rather poorly with growth of –2.2% YoY and 3.7% YoY respectively (compared to 6.9% YoY and 9.4% YoY respectively same period last year). Though power/electricity sector was a bright spot with growth jumping from 4.5%YoY April to October last year to 8.9% YoY same period this year. On a use basis in April-October '11, both capital goods and consumer goods reported a poor growth of -0.3% YoY and 3.7% YoY respectively ( compared to 17.1% YoY and 9.1% YoY respectively same period last year), indicating to a slowdown in consumption and investment demand. Though one of the leading indicators of economic activity, the manufacturing PMI numbers for the month of December '11 came in at a surprisingly strong 54.2 (51 in November '11) led by a strong pick up in output and new export orders. Input price increase continued to remain high, while output prices rose faster than previous month. Considering the numbers, core sector inflation continues to be an issue.

On 16th December '11 RBI came out with its mid quarter monetary policy review in which it kept all key policy rates unchanged. Explaining its policy RBI stated that “Both inflation and inflation expectations are currently above the comfort level of the Reserve Bank. However, reassuringly, inflationary pressures are expected to abate in the coming months despite high crude oil prices and rupee depreciation. The growth deceleration is contributing to a decline in inflation momentum, which is also being helped by softening food inflation.” Giving guidance for the future RBI states “The guidance given in the second quarter review was that, based on the projected inflation trajectory, further rate hikes might not be warranted. In view of the moderating growth momentum and higher downside risks to growth, this guidance is being reiterated. From this point on, monetary policy actions are likely to reverse the cycle, responding to the risks to growth.” From here on, considering the guidance, markets will be on the lookout for monetary easing actions of the RBI, in face of softening growth expectations.

On liquidity conditions it states “There are currently no significant signs of stress in the money market. The overnight call money rate is stable around the policy repo rate and liquidity facilities such as marginal standing facility (MSF) remain unutilized. However, in view of the fact that borrowings from the LAF are persistently above the Reserve Bank's comfort zone, further open market operations will be conducted as and when seen to be appropriate”.

The trade deficit has increased on imports being less elastic than exports to slowing world growth scenario; this has impacted the Indian rupee causing depreciation in its value against other currencies. Also, speculative interests have added to volatility of exchange rates. To enhance capital inflows, RBI has deregulated interest rates on non – resident deposits and relaxed External Commercial borrowing levels. RBI has also encouraged FII flows by permitting individual foreign investors to invest directly in Indian markets. Besides these measures RBI has relaxed foreign investment rules for Indian debt instruments and taken administrative measures to reduce speculation by discouraging the use of forward contracts for probable exposures. Further opening of more sectors to Foreign Direct Investment is also being mulled in government circles.

Emerging market economies have been impacted by sluggish growth of developed economies and tightening of monetary policy to control inflation. However, now that their growth is slowing, many emerging markets like Brazil, Indonesia, Israel and Thailand are increasingly using their greater monetary capacity to cut interest rates/ cost of capital as compared to the developed economies that are already at near zero interest rates, to support economic growth. Investors may also note that in the latter part of the month the market exhibited relief on announcement of the European Central Banks decision to provide unlimited funding to euro area banks at concessional rate of 1%. If the issue at stake was liquidity, we think the euro area debt crises would have been solved. However it’s an issue of solvency, hence banks will be loath to lend out funds they receive, instead choosing to use them to deleverage and shore up capital. Hence the year-end rally may only assuage markets, buying policy makers the crucial time to create a real plan to solve the solvency issue of European institutions. Considering all this we think longer term emerging markets are the new home of a more robust capitalistic system rather than the former group of nations named as developed economies.

In terms of outlook for January '12, investors will look to get indications of FII allocations in the calendar year 2012.Corporate results for the quarter ended December '11 and RBI third quarter review of monetary policy will influence domestic market sentiments. Progress of the European debt crises, along with economic data from big economies like US, China etc will continue to impact global investor sentiment.