Indian equities insipid performance in March continued in April as well with both domestic and global concerns playing their part. The continuing uncertainty on GAAR, RBI’s guidance of limited room for further rate cuts, renewed weakness in incoming US data, resurfacing of European problems and associated weakness in the rupee weighed on market sentiments.

Risk aversion was back in vogue as global equities tumbled in April. As in March, developed markets outperformed emerging markets peers in April as well. US indices stumbled in April but owing to relatively robust trailing 12 -month returns, are now trading close to their four year highs. At the current level, the US Dow Jones Index is ~10% away from its all time peak in October 2007. In comparison, on an average, emerging markets’ equities are still 15 - 20% away from their peaks.

US Q1CY12 GDP growth came in at 2.2% QoQ annualised, lower than expectation as well as Q4 CY11 GDP growth of 3.0%. This is one of the weakest post recession recoveries on record and suggests that the US recovery remain fragile. Meanwhile, on the global front, after a brief lull, Eurozone troubles have resurfaced with Spanish and Italian sovereign bond spreads (over German bunds) climbing in response to the weakening growth prospects and worsening debt dynamics. Purchasing Managers Index (PMI) data from Europe remains in the negative territory and Europe is clearly headed for a recession with even Germany’s growth coming under pressure. The continuing debate and disagreement over austerity resulted in the fall of the government in Netherlands, once a strong proponent of austerity. In France and Greece, political parties that have opposed austerity have witnessed a wave of support in their favour. This continuing saga is keeping markets on the edge.

The relevance of the European troubles on India is due to the sizeable exposure of European Banks to India and their tendency to retrench their exposure across emerging markets as risk aversion rises. For example, as per BIS data, European banks have retrenched their exposure to India from ~USD160bn in June 2011 to ~USD146bn in December 2011, the phase during which global risk aversion was high. This trend may be at play in April as well.

Apart from general risk aversion, local factors such as GAAR also contributed to the lackluster capital flows to India. For example, in April FIIs were net sellers to the tune of USD120mn, starkly different from USD8.5bn recorded for Q4FY12. Meanwhile, the impact on INR has been exaggerated because of elevated underlying current account deficit (CAD). As per latest data, CAD stood at ~4.2% of GDP in December 2011, while FY12 trade deficit stands at ~10% of GDP, a record high. A look at global emerging market currencies indicates that deficit currencies such as South African Rand, Brazilian Real and MXN have been hit the maximum.

Growth in India remains sluggish. The February Industrial production print @ 4.1% was below expectations. However, the February print appears more plausible and is free of incredible data surges in any one sub-component. The good news is that inflation continues to be moderate. Headline inflation expectedly dipped very modestly to 6.9%yoy in March from 7% in February. Core inflation fell to its lowest print in last two years of 4.7%. Some of the moderation in year-on-year core inflation is because of a large, favorable base effect from last year. However, the momentum of core has also eased in recent months. The problem in interpreting this data is that the inflation numbers are being suppressed by the large subsidy being borne by the government on account of energy prices. This results in a rising fiscal deficit even as inflation numbers stay unaffected by the rise in global prices. This also means that consumption trends for energy are unaffected by the rise in prices i.e. the consumption discipline brought about by higher prices is absent.

The RBI, in a surprise move, cut the repo rate by 50bps and kept CRR unchanged in its annual policy review. With this, the repo rate stands at 8%, reverse repo at 7% and CRR at 4.75%. The cut is based on two considerations—growth slowdown and fall in core inflation. The real GDP growth rate has declined to ~6.1% in Q3FY12 (below trend growth rate) and core inflation has declined significantly from ~7.7 % in December to ~4.7% in March reflecting easing demand pressures. However, overall tone of policy statements was neutral as RBI in its guidance on future monetary policy highlights limited available room for further reduction in policy rates. The primary reason for such guidance is that the economy is operating below potential, but only with a modest output gap, and secondly, upside risks to inflation still persist. Banks have started responding to the RBI move by lowering their base rates, but have not been that aggressive because the rate curve has not moved lower though the curve itself has flattened unlike the inversion visible in March.

Our strategy remains unchanged. Valuations are slightly below long term average and do offer some comfort. The macro environment, however, remains weak and challenging both in India and globally. But the focus will now be on an inflexion point in growth and earnings. The less cyclical components of the market are trading at rich valuations and pockets of under valuation exist in the cyclical areas. Our focus now is more on the stock picking as valuations and macroeconomic markers do not provide a clear signpost.

Disclaimer: These views have been expressed by Mr. Vetri Subramaniam, Chief Investment Officer, of Religare Asset Management Company Limited. All opinions included in this document constitute the author’s views as of this date and are subject to change without notice. The stocks referred in this document, if any, are for the purpose of explaining the concepts and should not be construed as recommendations from Religare Asset Management Company Ltd. (Religare AMC)/ Religare Mutual Fund (RMF). The Fund may or may not have any present or future positions in these stocks. The commentary is for information purposes only and not an offer to sell or a solicitation to buy units of Schemes of RMF. All figures, charts/graphs, estimates and data included in this document are as of this date and are subject to change without notice. The data used in this material is obtained by Religare AMC from the sources which it considers reliable. Neither Religare AMC nor any person connected with it accepts any liability arising from the use of this information or in respect of anything done in reliance of the contents of this information. While utmost care has been exercised while preparing this document, Religare AMC does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. This information alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy. It should not be construed as investment advice to any party. The recipient of this material should exercise due caution and/or seek independent professional advice before making any investment decision or entering into any financial obligation based on information, statement or opinion which is expressed herein.

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