InternationalGlobal financial markets witnessed broad-based declines after the US Federal Reserve outlined plans totaper asset purchases.The MSCI AC World Index ended 3.21% lower than last week levels and EmergingMarkets (EM) stock indices saw steeper declines on record outflows. Weak manufacturing data out ofChina also added to investor pessimism. Global treasury bond yields spiked as investors assessed impactof a less accommodative stance by central banks. Several EM nations cut/canceled scheduled bond salesdue to the market volatility. Commodity prices also reacted sharply to the statement and the ReutersJefferies CRB Index declined 2.83%. Gold retreated below the $1300/ounce mark and Brent futuresended a tad above $100/barrel levels as the US dollar strengthened. Central banks in Emerging marketstook a range of measures to stem currency depreciation.• Asia-Pacific: Global investor reallocation away from EMs caused sharp declines in EM Asian equity markets.Indonesia and China were amongst the top losers.A fall in HSBC’s flash China manufacturing PMI index to48.3 from 49.2 in May exacerbated weakness. Late in the week, the People’s Bank of China injected about$8.2 bln to address the systemic liquidity tightness, after Chinese inter-bank money markets rates recordedsharp increases. Japanese equity markets bucked the global trend, helped by a weaker yen and positiveeconomic data. Data showed yen depreciation had added to demand for Japanese goods and value of thecountry’s exports rose 10%yoy in May.The JapaneseTankan index also gained showing business sentiment hasstrengthened from latest measures.• Europe: Concerns that the turning point in the global central bank stimulus cycle is near weighed onregional equity markets. Closure of Greek state broadcaster ERT caused a rift between coalition partnersof the incumbent government and impacted Greek markets. Eurozone ministers agreed for the group’sbailout fund to inject funds directly into ailing banks, but only after local governments shared part of theburden. On the economic front, the Eurozone flash PMI indices continued to inch higher and UK retailsales were quite strong in May. Sweden government managed to sell a 13.4% stake in Nordea for $3 bln,which may be used to pare public sector debt. Spain announced it will rationalize/streamline governmentbody operations and expects such efforts to save €6.5 bln each year.• Americas: The CBOE VIX index jumped about 22% and US equity markets reacted negatively to the Fedpolicy statement. The Fed upgraded economic growth forecasts and said it could start winding down assetpurchases later this year and halt QE by mid-2014, if economy continues to recover as per expectations.Meanwhile, US housing sector data remained positive and the Conference Board’s index of leading indicatorsrose 0.1%.The Brazilian government rolled back the hike in public bus fares, but citizens continued to stageprotests against economic conditions. Colombia’s GDP report indicated slower economic expansion in Q1-2013 – 2.8%yoy versus 3.1%yoy corresponding quarter a year ago. On the corporate front, Brazil’sVotorantimCementi deferred close to $5 bln IPO plans.Market ReviewWEEK ENDED JUNE 21, 2013
Weekly Weeklychange (%) change (%)MSCI AC World Index -0.70 Xetra DAX -1.54FTSE Eurotop 100 -1.74 CAC 40 -1.74MSCI AC Asia Pacific 0.33 FTSE 100 -1.62Dow Jones -1.17 Hang Seng -2.81Nasdaq -1.32 Nikkei -1.48S&P 500 -1.01 KOSPI -1.80India - EquityThe weakness in EM countries weighed on India as well and domestic equity markets witnesseddeclines, albeit less than some of the EM peers. Except technology, all sectoral indices closed in the red,and real estate, metals and banking were the top losers. FIIs sold equities to the tune of $550 mln inthe first four trading days of the week.The fall in Indian equities in recent weeks needs to be seen in the context of the short term globalreallocation away from EM assets, amidst concerns about a reversal in global liquidity trends.The nearzero interest rates along with quantitative easing had led to a rise in global investors increasingallocations to EM countries such as India to benefit from relatively higher growth. Notwithstandingthe current slowdown, EM economies remain fundamentally well placed compared to the developedmarkets, due to positive demographics, rising income levels and infrastructure investments. Moreimportantly, many of the EM countries remain relatively less leveraged and the financial systems arequite robust. We believe these countries will continue to grow at a stronger pace than developedmarkets in the coming years. Hence, once the short term reactions to global liquidity trends play out,the long term fundamental story will attract global investors.Having said that, over the near term, FII outflows and the domestic CAD (current account deficit)situation, in particular, may cause markets and the currency to remain under pressure. Some of thepoints to consider in the current situation would be -• Economy/Policy: Economic growth has moderated over the last couple of years, but the key factorsbehind the slowdown seem to be on the mend, and a gradual recovery seems to be underway. As wehave mentioned in the past, favourable monsoons, spending ahead of elections and reduced inflationarypressures should help. The government has made progress on the fiscal consolidation front and projectexecution bottlenecks are easing, albeit slowly.The Cabinet Committee on Investments is functional andreportedly about $25 bln worth projects have been cleared.This week the government cleared a proposalfor pass-through of imported coal prices – this could potentially improve fuel availability for powerplayers, though will push up the import bill and increased tariffs.• Rupee/Foreign Flows: The recent rupee depreciation is likely to offset potential benefits from thefall in global crude oil and commodity prices, but could benefit exporters. Besides, higher domestic goldprices along with government measures could help rein in domestic gold demand.We will however needto be see if the rupee’s impact on export competitiveness is undermined due to a similar decline seenin EM peer currencies.
Source:Various Stock Exchanges.Source: RIMES, MSCI, Morgan Stanley Research• Valuations: India equities remain attractively valued vis-à-vis earnings potential and compared tohistory. Higher ROE apart, lower earnings cyclicality also strengthens the investment case for India.Weekly change (%)S&P BSE Sensex -2.10CNX Nifty -2.42CNX 500 -2.34CNX Midcap -2.27S&P BSE Smallcap -0.96India - DebtIndian bond yields continued to rise and the rupee weakened to record lows as traders reacted to USFederal Reserve plans to reduce stimulus. However, the pace of FII outflows slowed to about $650 mln inthe first four trading days and foreign investors subscribed to about Rs 39171 crore of governmentsecurities quotas vis-à-vis Rs. 42,022 crore on offer in the auction this week.At the mid-quarter monetary policy review, the RBI kept policy on hold due to current account deficitand inflation concerns• Yield movements: Bond yields increased across maturity buckets.Yields on the 10-year and 5-yearpapers increased by 10 bps and 17 bps respectively, while those on the 1-year paper rose 13 bps.Yieldon the 30 year Gilts also stood 13 bps higher than last week levels.Yields on 5-year AAA corporate bonds increased 21 bps (to 8.72%) and consequently spreads oversimilar tenured gilts rose to 111 bps from 107 bps a week ago.• Liquidity/borrowings: Systemic liquidity conditions were little changed - overnight call money ratesclosed at 7.20%, almost same levels as the prior week, and demand for liquidity at RBI’s LAF windowaveraged about Rs. 67,000 crores. Scheduled bond auctions of GOI securities worth Rs. 15,000 croreswitnessed good response from market participants and there was no devolvement on primary dealers.• Forex: The rupee dropped to fresh all-time lows of Rs.59.98/$ after the Fed’s stimulus withdrawal planhelped the US$ strengthen and caused FII outflows from Emerging Markets including India. RBIintervention and inflows related to a $1 bln overseas loan by Essar Steel helped the currency recoverslightly on Friday.Figure 1: Net foreign buying in Emerging Asia (ex-China, ex-Malaysia)EM Asiaex-China &India Indonesia Korea Philippines Taiwan Thailand MalaysiaMonthly dataJan-13 4,059 590 -1,746 667 671 500 4,742Feb-13 4,575 1,161 1,760 146 1,052 -583 8,111Mar-13 1,675 188 -1,901 204 -902 212 -524Apr-13 1,000 74 -2,589 284 1,068 -683 -845May-13 4,067 -36 926 450 2,142 -173 7,376Jun-13 -412 -1,596 -3,476 -265 -2,351 -1,178 -9,278Annual data2013 (YTD) 14,966 381 -7,025 1,485 1,680 -1,905 9,5822012 24,372 1,694 14,990 2,540 5,006 2,502 51,1042011 -358 1,163 -8,762 1,326 -9,178 -196 -16,005Last update: 19 Jun 20131.01.11.21.126.96.36.199.720052005200620062007200720082008200920092010201020112011201220122013M SCI India ROE Relative to M SCI EM
As we have mentioned in the past, the rupees sharp decline is not isolated - many EM currencies witnessedsimilar declines – the chart below captures 2013YTD movement in the rupee and other EM currencies.Select EM Currencies – 2013YTD Fall Against the USDSource: MSCI, RIMES, Morgan Stanley Research.‘EM’ here is represented by the MSCI Emerging Markets Currency Index• Policy: RBI’s decision to keep key rates unchanged (repo at 7.25% and CRR at 4%) was in line withexpectations, given the macroeconomic backdrop both in India and overseas. The bank acknowledged theuneven global growth and increased risks of sudden changes to capital flows due to the monetary policy stanceof important central banks such as the Federal Reserve. Notwithstanding the weak growth trends in India, ithas indicated that uncertain inflation outlook has weighed on its policy stance. Key factors impacting inflationoutlook are – still elevated consumer inflation levels, potential increase in imported inflationary pressures dueto rupee depreciation and upward revisions to domestic fuel as well as minimum support prices (MSP).• Outlook: While the recent global news flow has unnerved investors across markets, the changes outlined areinevitable. Leading global central banks had resorted to extraordinary policy actions to stem growth slowdownand aid de-leveraging. With the situation improving in the US, policymakers are signalling a gradualwithdrawal. The exit is expected to impact short-term flows into Emerging Market assets, but long terminvestors should continue to focus on fundamental stories such as India.In terms of India’s monetary policy, the latest statement indicates RBI is focused on durable/sustainable fall ininflationary pressures and the Balance of Payments situation.The improvement in case of the former may be limitedover the near term as rupee depreciation limits pass through of fall in international commodity prices. Thegovernment has been undertaking various measures to encourage foreign investments and reduce non-productivegold imports, and trends will be closely watched to gauge impact on external position.While the measures mayprovide some relief in the coming quarters, from a medium to long term perspective, there is clearly a need toaddress the structural drivers of domestic inflation (read bottlenecks) and boost investment activity. RBI hasindicated it will remain on stand-by to intervene and alleviate stress caused by adverse developments.We believe that Indian corporate bonds may fare relatively better than gilts in the current environmentprimarily due to their relatively high yields (read coupon payments) along with limited supply going forward.Gilt yields at the same time would be subject to fiscal deficit/borrowings news flow.Monetary policy directionis likely to be driven by trends in rupee, inflation and deficits situation.21.06.2013 14.06.2013Exchange rate (Rs./$) 59.27 57.51Average repos (Rs. Cr) 67,713 65,4131-yr gilt yield (%) 7.47 7.345-yr gilt yield (%) 7.61 7.4410-yr gilt yield (%) 7.57 7.47Source: Reuters, CCIL.-10.4-3.0-20.9-8.3-9.1-4.4-25.0-20.0-15.0-10.0-5.00.0Brazil Indonesia South Africa Turkey India EM