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Month gone by – A snapshot: Global geo-political tensions kept equity market sentiments weak in August. While developed market equities declined marginally, the first time in 10 months, emerging market (EM) equities ended higher. Indian equity market, however, underperformed the broader EM pack. Domestic bond yields traded in a range-bound manner with a negative bias even as global bond yields declined sharply amid risk-off sentiments.

Pre-GST disruptions drag Q1 FY18 GDP growth lower
The GDP growth in Q1 FY18 slowed to three-year low of 5.7% vs. 6.1% in Q4 FY17. The slowdown is largely attributed to 1) inventory de-stocking in the run-up to GST implementation, thereby dragging manufacturing sector growth to five-year low level and 2) sharp negative contribution from net exports. However, GDP growth seems to have bottomed out and is expected to recover gradually over coming quarters on inventory restocking, pick-up in consumption and favourable base. The key downside risks include reduced space for fiscal spending and GST-led transient disruptions.

Demonetisation provides a boost to household financial savings
The net household financial savings as share of GDP increased from 7.9% in FY16 to seven-year high of 8.2% in FY17. This was largely led by higher allocation to deposits, shares and debentures and life insurance funds, facilitated by a sharp increase in banking system liquidity post demonetisation. We expect a continued shift in household savings from physical to financial assets supported by higher financial inclusion, lower inflationary scenario and increasing awareness.

Fixed income market performance
Fixed income market remains range-bound: Following an expected 25bps policy rate cut by RBI, fixed income market traded in a range-bound manner with a negative bias in August. This was despite strong foreign capital inflows (August: $2.4bn; YTD: $20bn) and a sharp decline in global bond yields last month amid geo-political tensions. The key factors that impacted market last month include 1) pick-up in inflation, 2) lower-than-budgeted transfer of RBI surplus to government and 3) dry spell during the month. The 10-year G-sec yield rose by 7bps to end the month at 6.5%.

Outlook: A lacklustre Q1 FY18 GDP print has resulted in renewed expectations of a rate cut. However, inflation trajectory is expected to shift upwards in H2 FY18 led by higher food prices, implementation of government’s HRA allowance under 7th Pay Commission and unfavourable base effect. As such, yields are likely to remain range-bound in the near-term. The key factors that are likely to influence fixed income market in the near-term include 1) inflation and growth trajectory going forward and 2) steps taken by RBI to absorb excess liquidity.

Equity market performance
Equity market consolidates: After a strong July, equity markets consolidated in August, underperforming the broader EM pack. The key factors leading to underperformance were weak corporate earnings and global geo-political tensions. Foreign institutional investors (FIIs) turned sellers after three months, with net FII outflows at $1.7bn in August. However, domestic institutional investors continued to remain strong buyers with net inflows at $2.5bn. The Nifty index declined by 1.6% in August (YTD: +21%) while the mid-cap index was up by a modest 1% (YTD: +29%).

Outlook: Given rich valuations, equity markets may remain in consolidation mode in the near-term. Corporate earnings over last two quarters have been impacted due to demonetisation and GST. We expect a pick-up in corporate earnings over next few quarters led by inventory restocking, revival in consumption demand and favourable base. This, along with GST-led efficiency gains and sustenance of robust domestic flows, bodes well for equity markets in the medium-term. On the global front, geo-political landscape and monetary policy stance of global central banks are crucial for FII flows.