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A Changing of the Guard

Oct 10, 2016


The big news this week is the change in policy methodology by RBI. We look at the implications for markets and the economy. Further, the dichotomy in prospects for emerging versus developed economies is becoming evident in institutional investor rhetoric and is a net positive for India.

Diverging Economic Prospects

Consider the current rhetoric about the prospects for developed markets and emerging markets. Ray Dalio is the manager of one of the largest hedge funds in the world and recently spoke at the Fed about the current economic environment:

It is no longer controversial to say this isn’t a normal business cycle and developed markets are likely in an environment of abnormally slow growth… There is only so much one can squeeze out of a debt cycle and most countries are approaching those limits… Japan is closest to its limits, Europe a step behind, the U.S. a step or two behind Europe, and China a few steps behind the U.S. The risks are asymmetrically to the downside… Returns will be low going forward, alongside dangerous populism and nationalism amongst the lower and middle class.

– Ray Dalio, Hedge Fund Manager, Bridgewater Associates

India is a very clear long term story, based on demographics, banking penetration and government reform from a low base. The demographic arguments in themselves are very powerful. India is an insular market. How do you not own Indian banks structurally when there’s 3% to 5% credit card penetration. These sort of numbers are headed one way…up. The profitability of Indian banks is very different if they get penetration to just some sort of emerging market median.

– Paul Krake, Emerging Markets Hedge Fund Manager

Given the overwhelming amount of data, much of it dismal, coming out of the U.S., one is tempted to paint the world in broad strokes and assume a risk averse mind-set. A divergence, however, is becoming increasingly evident in the future prospects for developed and emerging markets.

Institutional funds have been underweight Asian markets the past few years. These underweight positions are now being reversed. We’re in the midst of a global yield grab and some of the best growth companies in the emerging markets universe are Indian. We think it’s increasingly a tale of two markets and investors would do well to recognize the barbell shaped nature of risk and opportunity.

India Economy

Car Sales Again Suggest the Indian Consumer is Healthy

The Indian Consumer Appears to Be in the Healthiest Shape in at least 5 Years

The Indian Consumer Appears to Be in the Healthiest Shape in at least 5 Years

Car sales are cyclical as would be expected being a big ticket purchase. Consumers tend to purchase new cars when the economy is doing well and their confidence is high. When times are tough, car purchases are deferred and consumers often choose to put off large ticket purchases. What’s clear from the robust domestic automobile sales data is that the Indian consumer is healthy, confident, optimistic, acquisitive and increasingly aspirational.

Auto volumes reported by SIAM in September improved impressively by 20.2% year over year, driven primarily by good growth in Utility Vehicles and 2-wheelers.

Consumers are expected to spend Rs 25,000 crore this festive season, a rise of 25 percent, as against Rs 20,000 crore spent in the year ago period, according to Assocham.

PMI Weakens Slightly But Still in Growth Territory

India’s composite PMI reported a reading of 52.4 in Sep-16 from 54.6 the prior month. Services PMI declined to 52.0 from 54.7 and manufacturing PMI was essentially unchanged. We also got good core industry growth at 3.2% in Aug-16 with 5 out of 8 core sectors witnessing an expansion. The economy remains in growth mode. Acknowledging the positive news flow, the IMF in its latest World Economic Outlook update upped India’s FY17 GDP growth forecast by 20 bps to 7.6%.

Government Project Momentum Is Picking Up

New projects announced in Q2FY17 are on the rise as per the CMIE, particularly in Manufacturing and Transportation. Furthermore, reasons for stalled projects have shifted from government bottlenecks to promoter related and other issues. A majority of the pickup in growth can be attributed to investments happening on the ground that are being executed and carried out by the State governments. The Modi government is asking States to compete for investments and follow the Gujarat model, which has been phenomenally successful over the past fifteen years.

Fixed Income

The RBI continued to maintain an accommodative stance. Under the first review of the newly formed Monetary Policy Committee (MPC) of the RBI, the key policy repo rate was cut by 25bps to 6.25%. The MPC reiterated a CPI target of 5% by Mar ’17 while the medium term CPI target remains 4% ± 2%.

However, the RBI shifted its focus from the previous Governor’s strict inflation targeting methodology to maintenance of a real interest rate spread.

In doing so, the RBI introduced a degree of opaqueness into its policy setting methodology. According to Dr. Patra, the neutral rate is a time varying concept and does not stay still at a point in time. The world over, the sense is that the neutral rate is headed lower, and in many instances, to negative. The definition Dr. Patra used is based on the Treasury Bill rate which is 6.5% and inflation expectations, which are an RBI projection, at 5%, to arrive at a real rate of 1.5%.

The inflation targeted approach was elegant, simple and data driven. The new methodology is opaque, fluid and subject to significant interpretation. In fact, the band on the neutral real interest rate could vary significantly and it is unclear even to the RBI whether the real neutral rate today is 1.25% or a different number.

On neutral rate, there can’t be one precise number. It has to be a range. In fact central banks in most countries talk about a broad range and in fact when they describe policy they say it is broadly neutral. Their words are used very carefully to convey a sense of uncertainty.

Using the MPC’s definition of the T-bill rate of 6.5% and the CPI as a proxy for inflation expectations to create a real interest rate series, it’s evident that the real interest rate has varied considerably over the past few years.

Real Rates Have Varied Significantly Over the Past 5 Years

Real Rates Have Varied Significantly Over the Past 5 Years

Net net, markets love clarity. The move away from clarity appears intentional, and intended to open the door for the MPC to reduce rates moving forward and shift to a pro-growth environment. Fortunately, markets also love accommodative policy. The move to an accommodative policy is a welcome move for equity and debt investors in the short to medium term, while the jury remains out on the longer term.

While bond yields plunged last week with the 10 year Govt. bond yield touching as low as 6.67%, there were outflows by foreign investors in the Indian debt market in the month of Oct-16.

We continue to suggest medium term accrual funds and selective offerings of preference shares as part of the core debt portfolio allocation. We’ve been directionally right in terms of rates headed lower since late June and we continue to believe rates are headed lower. The risk reward for tactical exposure to rate driven products remains attractive in the shorter term.


A potential liquidity crunch could be witnessed going forward as the U.S. economy has been making noises that a rate hike could be on the cards in December and the ECB as well has been signalling towards a quantitative tapering. In terms of equities, we believe this could potentially paint the Indian growth story in a more attractive light as the macro stability here will drive higher flows into India.


  • U.S. presidential elections are to be held on 08 Nov 2016. The first debate potentially swung the way in favour of Hillary Clinton with several polls showing her to have a slender edge over Trump. The Vice Presidential debate was a win for the Republicans but the battle just got nasty over the weekend and it will likely get uglier as we approach November.
  • Fed rate hike probability for the Dec-16 FOMC meeting (13-Dec-16) has increased to 64% from 50% last week on the back of better jobs data. The unemployment rate for September came in at 4.9%, better than expectations of 5%, and there was expansion in services with the Markit U.S. Services PMI coming in at 52.3 versus expectations of 51.9.


Quantitative tapering: ECB’s Mario Draghi has been looking to gather consensus for a tapering of its bond purchasing program scheduled to end at Mar-17. The ECB may slow down the purchases by 10 billion euros a month post end date, according to euro-zone central-bank officials. The targeted pace of bond purchases is to the tune of €80bn/month on average.

Crude Oil

OPEC has tentatively agreed to a 700,000-750,000 barrels per day cut to ~32.5m bpd. This could potentially indicate the stress on the fiscal deficit of its members, most notably Saudi Arabia. Brent Crude rallied significantly since the announcement. The exact allocations of the cut within the member countries will be decided on 30-Nov-16.


The decline in the last week of September led to the Nifty breaking below the medium term rising trend line and trading below it at 8698 level. The recovery from low of 8562 on 30th September faced resistance above 8800 levels, where the short term falling trend line is evident.

Momentum indicators have given a negative crossover and turned down on weekly chart from overbought levels which is a negative for the market. In the short term, the zone of 8550-8500 which offered support to the market will be the level to watch on the downside.

FII long positions in index future positions have remained at same level as last week, but significant reduction in positions was seen at the time of rollover to October series. Also, the overall index future positions are lighter by 30% compared to the September series which is a positive for the market. But in index options FIIs have built up significant bearish positions, suggesting market could remain under pressure.

Nifty options put call ratio is also below one level at 0.96 which is negative. India VIX has seen drop from high of 19.12 on 29th September high to 14.49 levels on market pullback. So, rise in VIX will be a cause of concern for the market; however if volatility remains at current levels, market is likely to see sideways action between 8800 and 8550 odd levels in the short term. Strength in the index will be seen once it starts to trade above 8810 levels on a tradable basis. On the downside 8500 level is major support for the market, breaking below which market is likely to see 8300-8260 levels.

Nifty 50 Weekly Technical Chart

Nifty 50 Weekly Technical Chart


India is looking increasingly to be entering a multiple year growth cycle. The rate cut by the RBI signals a more accommodative stance and this provide yet another floor to equities. The consumer remains healthy and we think earnings announcements will continue the recovery trend of the past couple of quarters. U.S. elections, however, could create volatility in coming weeks.

The move by the RBI signals a commitment to reinvigorate growth in the domestic economy. The Nifty 50 has remained roughly range bound for almost three months now. We’d note, however, that the movement in attractive growth stocks has been anything but and quality growth stocks continue to march higher.