Financial Market @ November 2016

Reawakening of Tiger called India

The move to ban high-denomination notes is expected to dent immediate consumption in the medium-term, but will have a positive impact on growth and inflation in the long run. This move is also deflationary as the currency in circulation comes down for a while the spending power or consumption will reduce. Lesser amount of economic activities is expected in next 6 to 8 months of time frame.

There will be lesser action seen on the bourses, right time to balance your portfolio. Debt funds as always better options than any of the debt product available in market. It will benefit the most with the expected rate cuts by RBI in next one year to the tune of 50 basis point.

Investment from long term perspective should start participating in equity distributing their investible surplus judiciously over next 6 to 8 month time frame.

Economic prospects never looked so strong in India before, since Independence. There will be initial corrections on account of slowing down of economy but much is expected from the FDI participation and offshore investments in due course of time.

Financial Market @ September 2016

India today stands at triple advantage positions.

Liquidity

Sentiments

Fundamentals

The liquidity in the system has been gradually modulated from a negative to positive. The Banking liquidity in the system was transformed from negative Rs 170,000 crs in Feb 16; to today, where the Liquidity is positive Rs. 63000 crs. This liquidity has eased the pressure on interest rates, in turn reduced the borrowing cost and has provided a demand flip for asset purchase. The stock market liquidity is driven by both domestic & foreign investors. Between Retail & Institutional players, demand for equity in FY17 in excess of 60% than potential supply between govt. disinvestment & issuance. This excess demand is keeping prices elevated.

The sentiments are improving on account of host of positive actions & reforms coming together:

·         The passage of GST bill

·         Good Monsoon

·         7^th pay commission

·         Thrust on improving the ease of doing business

All the above factors has boosted the sentiments of investors domestically & abroad (significant rise in the FDI & FII inflows - US$17.3 billion & US#6.2 billion respectively).

Most vitally, the fundamentals of the economy are on a very strong footing. The current account deficit has been tamed and stands at -1.06% of the GDP. The fiscal deficit in the economy is projected to be at 3.5% of GDP. The CPI inflation is at 6.05%, which while at the upper end of RBI’s threshold, is still well below the levels seen 2-3 years ago. Moreover, the low crude oil prices and good monsoon is expected to tame the food inflation over a period of 2-4 months and help mitigate the CPI inflationary pressure. This has led to a gradual reduction in the repo rate of around 150 bps point in this current rate reduction cycle. Moreover, the GDP growth rate is at above 7% and is expected to the 8% mark in the medium term future.

Having said that in short term the market volatility may hurt the investor but a long term view will yield positive results.

Investors with a low-moderate risk appetite can utilize various asset allocation strategies and still obtain the potential gains of equity while also reduce the risk exposure on their capital.

Brexit - A Non-Event for India

What is BREXIT?

The European Union - often known as the EU - is an economic and
political partnership involving 28 European countries. It has grown to
become a "single market" allowing goods and people to move around. The
United Kingdom Prime Minister, David Cameron at the time of his
election had promised to hold a referendum on whether the UK should
remain in the EU? The referendum has been held and the people of the
UK have voted 52:48 in favour of an Exit.

What were the stakes for the British?

The UK is one of 10 member states that pays more into the EU budget
than what they get out and only France and Germany contribute more.
The UK's net contribution for 2014/15 was �8.8bn - nearly double what
it was in 2009/10.

Post Brexit, Britain would also take back full control of its borders
and reduce the number of people coming to live and/or work i.e. it
will gain control over immigration within the UK-EU.

What happens next?

Technically, MPs could block an EU exit - but it would be seen as
political suicide to go against the will of the people as expressed in
a referendum.

The referendum result is not legally binding - Parliament still has to
pass the laws that will get Britain out of the EU.

Article 50 of the treaty with EU has to be activated by the UK PM. The
current PM has resigned and left it to the next PM to take a decision
on Article 50. Once Article 50 is activated, Brexit is certain. Brexit
should then be a two year negotiation process between the EU and the
UK. In a good case, it is possible that UK postpones invoking Article
50 for 6-12 months while negotiating better terms for the UK within
the EU and following up with a second referendum in 2017.

Brexit and Indian economy

It is hard to make a case of any meaningful impact on Indian economy
of Brexit – either direct or indirect. The UK is a small trading
partner of India – UK alone accounts for only 3.4% and 1.4% of
India’s merchandise exports and imports, respectively, as of FY16.
Even that should not be impacted as Brexit will change the terms of
trade between UK and EU and not with India. FDI flows from UK to India
stood at only US$1bn in FY15 and US$0.8bn in FY16; hence, not that
significant.

Source: Finance Ministry and RBI

Impact on Indian Companies

Brexit can have some impact on Indian companies that have businesses
in UK/ EU.

The medium term impact, if any, will be clear only post the revised
terms of trade between UK and EU are finalized. This should take 2-3
years from now.

In the interim, the GBP depreciation is an unexpected positive for
companies like Tata Steel and Tata Motors (JLR) that have
manufacturing operations in the UK.

Barring these companies, the impact on other sectors like pharma, IT,
banks and agrochemicals is likely to be marginal.

Capital outflows

A pessimist may argue that Brexit will lead to FII outflows from India
due to risk aversion. While there is no meaningful link between Brexit
and Indian economy, India is in a strong position even if there are
some outflows. Consensus expects India’s CAD to remain manageable at
about ~1.5% of GDP in FY17. Foreign exchange reserves at ~US$363bn
seem adequate to withstand volatility in the case of global risk
aversion. Net FDI inflows have increased to an all-time high of
US$36bn in FY16. Impact of any FII outflows even if it does happen
will not be felt by the economy, though stock
markets may be impacted in the very short run.

Interest rates

Considering India's relatively stable macro situation (CAD ~1.5%,
Fiscal Deficit ~3.5% and stable inflation), we do not expect any
negative impact on the debt markets. Even if there are some FII
outflows, which may lead to liquidity tightening, RBI is likely to
provide additional liquidity through repos and purchase of Gsecs in
the open market operations (OMO).

Uncertainty in EU is likely to lead to USD strengthening and lower
global commodity prices. Interestingly, Brent oil prices were down ~4%
today. This is likely to aid continued low inflation and provide room
for lower rates in India.

The impact of Brexit on all segments of debt markets today has been
fairly muted. In the money market (CP & CD) and corporate bond market
- yields have moved higher by just 2 to 3 bps. While the yields in
treasury bills and government bond market are flat to lower as
compared to the levels prevailing yesterday.

The INR was stable and depreciated marginally vs. the USD while
appreciating against the Euro and the GBP.

Global events - opportunities for Indian equities?

The following table lists some of the adverse developments in the
world over the last two decades, the impact on the stock markets in
the short run in India and the returns one year after the event. It is
quite evident that on most of these occasions, the correction in the
Indian stock markets was a good opportunity to invest for the long
term investor. This is so because the nature of Indian economy is one
of secular growth and global developments have only a marginal impact
on it.

Table: Past global events and the returns thereafter

Source: Bloomberg

In our opinion, the Indian markets will quickly discount/recover from
Brexit. Interestingly, due to focus on Brexit, the steady improvement
in the Indian economy has been ignored. The table below gives the key
macro-economic indicators.

Source: Kotak Institutional Equities Research

The correction of Indian equities at a time when the Indian economy is
improving on nearly all parameters has created a good opportunity for
the discerning investor. The chart below presents Market cap/GDP ratio
of India. It can be seen from the chart that the Market cap/GDP has
fallen to attractive levels.

India market cap to GDP ratio, calendar year-ends 2005-15 (%)

Source: World Bank, Bloomberg, Kotak Institutional Equities, updated
till 31st March, 2016

The policy direction in India is right and economy is making good
progress on most fronts. The economy and equity markets also appear to
be in transition from consumption to capex. Impact of higher infra
allocation and the several steps taken by government over the last two
years is expected to be felt strongly from FY17 onwards with Railways,
Power Transmission and Distribution, Mining, Roads and Urban
Infrastructure likely to lead growth.

Improving fundamentals of the Indian economy and attractive market cap
/ GDP lead to a positive outlook for the equity markets over the
medium to long term.

In a lighter vein, Gold prices went up by ~5% today making Indians
richer by ~$40bn. Equity markets lost ~$30bn in value today. Hence,
Indians are actually better off from Brexit!

To conclude, Brexit is not a material event for the Indian markets.
Indian economy is on a steady recovery path and valuations are
attractive. The correction in markets thus provides an attractive
entry point for the medium to long term.

source: HDFC Mutual Fund, Bloomberg, Kotak Institutional Equities Research, World Bank

CREDIT POLICY REVIEW – JUNE 2016

In line with consensus expectations RBI kept all rates unchanged in its credit policy review. Thus the repo rate stays at 6.5% while the reverse repo rate stays at 6% and the Cash Reserve Ratio (CRR) also remains unchanged at 4% of net demand & time liability (NDTL).

The RBI has retained its GVA (Gross Value Added) growth projection for FY17 at 7.6%. The inflation projections given in the April’16 policy statement have also been retained but with an upside bias. Retail inflation in April’16 raised more than expected largely due to food prices and as per RBI, makes the future trajectory of inflation somewhat more uncertain. However, the expectations of normal monsoon and various supply management measures of the govt. should moderate unanticipated firming up of food prices.

In its forward guidance RBI has stated that “given the uncertainties, the RBI will stay on hold, but the stance of monetary policy remains accommodative. The RBI will monitor macro-economic & financial developments for any further scope for policy action.

We maintain our views on participating in equities via SIP with long term objective & pure debt for tenure less than two years.

Regards

UNION BUDGET 2016

The Union Budget for FY 2016-17 is on the path set by the government in its previous budget that focuses on infrastructure, rationalization of taxes and overall development of the economy. The Union Budget has delivered on fiscal prudence while keeping a strong impetus on rural economy and consumption growth.

The budget was wholly aimed at improving the infrastructure of the country, especially in road sector. With monsoon not being adequate for last two consecutive years, the rural economy is under pressure, and hence, the budget had many provisions addressing the rural segment of the economy.

Meanwhile, there was also impetus on entrepreneurship and rationalization of tax structure for start-ups and new setups in the manufacturing sector.

Key Positives

Adherence to fiscal deficit target: Despite the pressures on the Government budgets, the Government has gone ahead with a fiscal deficit target of 3.5% of GDP for FY17 vis-à-vis 3.9% of GDP for FY16. This is despite providing allowances for the 7th Pay Commission recommendations and the OROP (One Rank and One Pension) scheme. This is extremely positive for bond yields and will raise the chances of a policy rate cut by the Reserve Bank of India (RBI) in the near term.

Capex: The push for infra development continues. Budget allocation for roads is up 25% YoY (year-on- year) at Rs 550 billion. Rail capex allocation is also up 30% YoY at Rs 450 billion. Overall plan expenditure is up 15% YoY at Rs 5,500 billion.

Rural: The budget provided huge impetus to rural sector. To alleviate the stress on the rural economy, the government has increased its planned spending. Through various rural schemes, the Government is budgeting to spend Rs 876 billion in FY17 on rural development (including rural roads, interest subvention on agricultural-loan, crop insurance etc.). This is up 20% YoY.

Social spending gains impetus: Social welfare schemes relating to women and children, healthcare, and insurance schemes have continued. All these have long-term positive ramifications, as social spending is focused through the organised route of financial inclusion.

Capital expenditure directed towards higher multipliers: While central government capital spending is increasing by just 4%, spending on roads and railways is increasing by 36% and 40% respectively. Central government spending on infrastructure (including capital outlay for railways) for FY17 will be Rs 2.2trillon, implying an increase of 30% yoy.

Macro Highlights

v  Gross Domestic Product (GDP) growth at 7.6% despite slowdown in global economy from 3.4% to 3.1%.

v  Consumer Price Index (CPI) inflation down to 5.4%.

v  Foreign exchange reserves touched highest ever level of about USD 350 billion

v  Fiscal deficit roadmap retained, 3.9% in FY16 and 3.5% in FY17

v  CAD (Current Account Deficit) reduced from USD 18.4 billion in first half of last year to USD 14.4 billion this year

v  Revenue Deficit target at 2.5% from 2.8% in FY 2015-16

v  15.3% increase in Plan Expenditure to Rs 5,500 billion; this is the last year of the 12th Plan. Total expenditure projected at Rs 19,781 bn.

v  Gross market borrowing at Rs 6 trillion and net borrowing at Rs 4.25 trillion. (Bond Market +ve)

v  Plan vs non-plan distinction to be replaced with Capital vs Revenue expenditure in FY2017.

v  Every new scheme to have sunset date and outcome review.

Key Changes in Direct taxes

Resident Individual Tax:

v  Citizens earning less than Rs. 5,00,000 p.a. to receive tax rebate of Rs 5,000 under Section 87A of The Income Tax Act, 1961. Earlier the tax rebate was Rs. 2,000.

v  Those living in rented houses and not getting HRA (House Rent Allowance) from employers to receive tax exemption up to Rs 60,000 under Section 80GG of The Income Tax Act, 1961. Earlier the exemption was Rs. 24,000.

v  First-time home-buyers to receive Rs. 50,000 as an additional tax exemption on interest payment for home loans up to Rs. 35 lakh for houses costing less than Rs. 50 lakh.

v    The government has given a 4-months window for individuals to declare income that was not disclosed to the Income Tax department under Income Declaration Scheme (IDS).

v  10% tax on dividends in excess of Rs 10 lakh received by individuals, HUFs (Hindu Undivided Families) and Firms under Section 115O of The Income Tax Act, 1961. (Applicable to dividend declared by domestic Indian Companies. Not applicable to dividends declared by Mutual Funds)

v  LTCG (Long Term Capital Gains) period for unlisted firms reduced to 2 years.

Corporate Tax:

v  Corporate tax: Accelerated depreciation limited to 40% of asset value for first year. IT rate for FY17 of relatively small enterprises, with turnover of less than Rs. 5 crore reduced to 29% plus cess.

v  10% tax on dividends in excess of Rs 10 lakh received by individuals, HUFs (Hindu Undivided Families); this will be in addition to DDT (Dividend Distribution Tax); LTCG (Long Term Capital Gains) period for unlisted firms reduced to 2 years.

v  100% deduction of profits for 3 out of 5 years for startups setup during April, 2016 to March, 2019.

MAT (Minimum Alternate Tax) to apply in such cases.

Our Outlook : 2016 – Year to look forward to equity Participation

·         We believe that Fin. Yr 2016-17 budget is a balanced budget where govt. has maintained its commitments towards fiscal consolidations.

·         This is done at the time when inflation is likely to be benign and when the economy faces headwinds from global economic concerns, lower output and balance sheet stress.

·         Govt. borrowing in 2016-17 has also been contained and this could lead the way for the RBI to ease policy rates further.

·         The Union Budget also underlines the Govt’s determination to provide an impetus to the economy especially through the infrastructure, rural and financial sectors. It lays emphasis on repairing balance sheets of the banks, reducing nonperforming assets and boosting employment in the largest section of the economic pyramid.

·         Given this focus on reform, repair and revival, we see a prospective up-cycle in the economy.

·         The recovery process could provide ample opportunities to accumulate equities in 2016.