India Market Outlook

31st July 2013

RBI in the limelight

Content Executive Summary Macro Bonds Equity Currency Pg 1 Pg 1 Pg 2 Pg 2 Pg 3 Executive Summary RBI announces monetary tightening measures to stem rupee fall. Bond yields spike across the board. Banking stocks slide. INR recovers partially, though only temporarily.

Indian Tactical Asset Allocation August 2013 Asset Class Equity Bonds Commodities Cash
Source: Standard Chartered

Macro The RBI seems to be in the limelight again as it announced a series of monetary tightening measures this month. The measures were inspired by the weakening rupee, which hit an all time low against the dollar in June. The move follows the Brazilian and Indonesian example of a rate hiking regime to curb currency volatility. The RBI announced its first set of policy measures on 15 th July, essentially aimed at curtailing the prevalent arbitrage activities in the foreign exchange market. The RBI announced restrictions on banks overnight borrowing facility and increased penal rates for these overnight borrowings beyond a certain threshold. By raising borrowing costs and restricting access to relatively cheap money, the RBI intends to reduce any speculation that may intensify the already prevalent and elevated rupee volatility. The immediate impact on overnight rates post the first policy announcement was limited, as the banks slipped through the cracks based on certain loopholes. The hawkish RBI was quick to clamp down on these gaps and announced another round of measures on 23rd July, eventually paving the way for a 300 bps rise in overnight rates. A key point to note is that the RBI has preferred not to tamper with either the repo rate or the CRR, indicating that the currently announced measures are temporary in nature and do not signal a reversal of broader monetary policy direction. On a positive note, the WPI index (wholesale price based inflation index) for June remained relatively restrained at 4.85% y/y, recording only a marginal increase from Mays 4.7% y/y. A sharp deterioration in producer pricing power and a still weak economic outlook are amongst the key factors that are likely to keep the WPI index in check over the longer term as these factors eventually outweigh concerns on recent increase in agricultural & fuel prices.

12 Month View Overweight Neutral Underweight Neutral

RBI: Repo, CRR held as Call rates spike

Repo Rate, Call Rate Index, Cash Reserve Ratio (CRR) (%) 11 10 9 8 7 6 5 4 3 2-Jul-13

9-Jul-13 CRR

16-Jul-13 Call Rate

23-Jul-13

30-Jul-13

Repo Rate

Source: Bloomberg, Standard Chartered

The RBI, in its policy announcement, kept key rates unchanged. This was in line with our expectations as recent measures have enabled the RBI to drive up short-term rates (notably the overnight rates) effectively, hence reducing the need for additional policy changes. The RBI may also have been partly constrained on account of a temporary upward blip in the WPI.

This commentary reflects the view of the Wealth Management Group of Standard Chartered Bank

Benchmark Yields: Yield spikes now value buys

Benchmark 10 year & 4 year GoISec yield (%) 9.50 9.00 8.50 8.00 7.50 7.00 6.50 2-Jul-13

Bonds RBI spooked the bond markets across the board as the recent RBI monetary tightening measures announced led to yield spikes across bond tenors. As highlighted in our Market Watch publication (released on 23rd July), the rise in yields has been more pronounced for the shorter term bonds which has resulted in an inversion of the yield curve i.e. shorter term bonds now offer higher yields than longer term ones. While this inversion may have led to near term pain for those invested in shorter term securities, the pain is relatively less than those invested in duration securities. To validate with an example, the 12 month total return (as on 26th July) for the benchmark 4 Y GoISec index was about 9.2% whereas the 12 month total return (as on 26th July) for the benchmark 10 Y GoISec index was about 0.48%. The numbers validate the benefit of holding short term securities as wed highlighted in the last two editions of the India Market Outlook.

9-Jul-13

16-Jul-13

23-Jul-13 GIND 4 Y

30-Jul-13

GIND 10 Y Source: Bloomberg, Standard Chartered

Given the recent yield gains in shorter term bonds, we consider the recent correction an opportunity to accelerate purchases in bonds with short maturity profiles (4 years and less). The prevailing yield on a benchmark 4 Y GoISec index currently quotes at about 8.7% and on a benchmark 1 Y GoISec index at about 9.1%. These levels indicate suitable investment levels for those comfortable with moderate levels of volatility. For the extremely conservative and those uncomfortable with the prevailing volatility surrounding interest rates, one can lock-in prevailing high interest rates by investing in bonds with 1 to 3 years of maturity. Reiterating the message from last weeks Market Watch, the recent correction in the benchmark 10 year GoISec seem overdone, representing oversold levels in our view. Weve seen the benchmark 10 Y GoISec yields retrace to 8.1% levels from a recent high of 8.4%. As the market gradually factors in rupee risks as well as supply concerns over the next few weeks, longer dated securities (notably the benchmark 10 Y GoISec) can be potentially rewarding over the year for those willing to accept some volatility in the interim. In summary, we reinforce our view from last weeks Market Watch: Risk-reward trade-off favours taking advantage of the prevailing high yields, we recommend accelerating purchases as the recent rise in yields seems somewhat overdone, in our view. Short maturity yields are at reasonably attractive levels, both from a historic as well as risk-adjusted perspective. Long duration is an opportunity for those willing to withstand volatility. Near term key risk on account of further rupee weakness remains. Equity The Indian equity markets rose for the majority of July, taking cues from the U.S. Feds announcements earlier in the month as Emerging markets across the globe rallied in tandem. Weakness prevailed towards the end of the month as RBI measures raised short term borrowing costs, mounting concerns on already fragile Indian economic growth.

Sensex: Jittery June

Sensex closing values, 12 Month Forward P/E multiple (RHS) 25000 25

20000

20

15000

15

Greater concerns persist on account of the potential fallout of RBI measures on the banking sector, (which comprises of a significant portion of the broader Indian indices) which has already been under pressure owing to poor credit growth and dwindling quality of assets, not to mention the mark to market losses on duration GoISecs for some of the larger public sector banks. Near term we see a case for heightened volatility as markets gradually price in these near term concerns, notably driven by the banking sector. Some green shoots in the form of an improving an improving trade deficit, subdued WPI numbers and a healthy monsoon should support the equity markets. From a technical perspective, the Sensex is likely to find support between the 18,000 and 18,500 mark and resistance between the 20,000 and 20,500 mark in the near to medium term. From a valuations perspective, the 1 year forward P/E is currently quoting at about 14.5x, still below the long term historical average of 15x.

10000

10

5000

0 3-Aug-08 3-Aug-09 3-Aug-10 3-Aug-11 Sensex 12M Forward P/E

0 3-Aug-12 5 Y P/E Average

Source: Bloomberg, Standard Chartered

This commentary reflects the view of the Wealth Management Group of Standard Chartered Bank

INR: Temporary respite

USD INR spot 62 61 60 59 58 57 56 55 54 53 52 31-Dec-12 28-Feb-13 30-Apr-13 30-Jun-13

Currency The recent steps by the RBI underscore its determination to curtail rupee volatility and stabilise the INR. While the initial bounce in the USD versus EM currencies in late Q1 and early Q2 was welcomed by the authorities in many EM countries, the mid-year extension of these USD gains has prompted steps to foster FX stability across a broad range of EM countries. The RBI has acted decisively, and the announced measures will likely prompt a rebound in the INR in the immediate near term. However, a sustained tightening of domestic liquidity conditions is a rather indirect way of calming FX markets. It risks simply boosting domestic interest rates and macroeconomic instability, while failing to tackle the underlying fundamental reasons for the deterioration in Indias current account balance. Absence of concrete, structural measures to fund the current account deficit will likely pave the way for a re-emergence of upward pressure on USD-INR.

Source: Standard Chartered

This commentary reflects the view of the Wealth Management Group of Standard Chartered Bank

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This commentary reflects the view of the Wealth Management Group of Standard Chartered Bank