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From CIO’s desk

Month gone by – A snapshot: February was another strong month for emerging market equities, including India. Fixed income market, however, fell sharply led by change in RBI’s monetary policy stance. The Impact of demonetisation has been softer-than-expected, with Q3 FY17 GDP growth and corporate earnings faring better-than-expectation. The US Fed policy meeting, outcome of state elections and classification of goods and services in tax brackets under GST are crucial factors for equity markets in the near-term. Yields are likely to remain firm amid unfavourable growth-inflation dynamics and rising global bond yields. 

Emerging markets rally for second consecutive month
Emerging market equities continued the strong show, facilitated by renewed participation by foreign institutional investors (FIIs) amid gradual global economic growth recovery. The US government’s stance on fiscal expansion remains intact, thereby providing a potential boost to economic growth. However, uncertainty about US trade policies remains. While the developed market index rose by 5% YTD, the emerging market index outperformed with 8.6% YTD return.  

GDP growth and corporate earnings signal limited impact of demonetisation
Q3 FY17 GDP growth at 7.0% came as a positive surprise. This was largely led by strong growth in private consumption, signalling lower-than-anticipated impact of demonetisation. Fixed capital formation rebounded after three consecutive quarters of negative growth. Further, Q3 FY17 corporate earnings have marginally beaten estimates. A meaningful rebound is expected in FY18 facilitated by a pick-up in economic activity, higher public spending and favourable base.  

Fixed income market performance
Fixed income market declines sharply: The RBI’s decision earlier this month to leave the policy rate unchanged and shift its stance from ‘accommodative’ to ‘neutral’ came as a surprise for fixed income markets. The reasons cited for the move were sticky core inflation and upside risks arising from increase in crude oil prices, exchange rate volatility and full implementation of 7th Pay Commission. This led to the 10-year g-sec yield rising by 46bps in February to 6.9%. The 30-year g-sec yield rose by 39bps to 7.4%. 

Outlook: The RBI’s neutral monetary policy stance and strong focus on meeting the 4% inflation target on a sustainable basis signals very limited room for monetary easing in the near-term. Moreover, there is a shift in liquidity dynamics with the easing of cash withdrawal limits. This, along with rising global bond yields amid strengthened expectations of rate hike by the US Fed, is likely to keep domestic bond yields firm in the near-term. 

Equity market performance
Equity market stays strong: Indian equity markets rallied for the second consecutive month, outperforming the broader EM pack. While Nifty Index rose by 3.7% in February (8.5% YTD), the rally in mid-cap index was stronger at 5.4% (12.6% YTD). This was led by better-than-expected Q3 FY17 corporate earnings, receding concerns on economic growth due to demonetisation and a prudent Union Budget. This led to renewed FII participation in February, with net FII inflows at US$ 1.6bn. Domestic institutional investors were modest buyers with net inflows at US$ 139mn.

Outlook: On the global front, the Fed policy meeting and US trade and fiscal policies remain crucial events for equity markets. On the domestic front, performance of corporate earnings, outcome of state elections and classification of goods and services in tax brackets under GST are likely to determine the trajectory of equity markets in the near-term. We remain positive on equity markets from a medium-term perspective on account of 1) revival in economic activity, 2) government reforms and 3) improvement in corporate earnings going forward.