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High frequency domestic growth indicators continue to suggest weakness in economy. IIP for May was weak, though better than market expectations. Data and corporate commentary continue to be weak in consumer products, auto sales has been abysmal, NONG imports have been weak, and infrastructure linked items like cement which was holding up has also weakened. PMI data is also suggesting weak- ness with composite PMIs steadily declining since February. Traffic indicators were mixed with railway and airport traffic weak while there was some pick-up in fuel consumption. Overall banking non-food credit growth, which had been growing strongly is also moderating even as personal loans remains strong led by strong growth in housing loans. Global backdrop also remains weak with weakness in world trade, industrial production and PMI. Manufacturing PMI declined further and remained below 50 for the second consecutive month.
Trade deficit for May was broadly unchanged at 15.4 bn in May. Growth in both exports and imports was muted at 3.9% and 4.3%. NONG imports continued to stay weak. Weakness continued in imports of electronics items (there was a small y-y uptick) as well as machinery items. The escalation of US-China trade tensions, would likely to continue putting pressure on world trade, which shall have a fallout on Indian exports as well. Balance of Payment went into surplus after 3 quarters in 4QFY20, both due to lower CAD and high capital account surplus. CAD for the 4QFY19 came down to US$4.6 bn (0.7% of GDP), lowest since March 2017 aided by lower merchandise deficit and stable invisibles. Capital account surplus was strong in the quarter aided by decent FPI inflows and external borrowings. We expect BoP to remain comfortable in FY20 with healthy surplus aided by low CAD and decent foreign capital inflows. Government’s announcement of foreign borrowing will also aid in BoP surplus.
Headline CPI inflation continued to remain benign at 3.05% YoY in May similar to the previous month. The divergence between food and core inflation continued to narrow with core inflation decelerating further to 4.1% (4.62% in April) and food inflation rising to 2.03% (1.38%). The decline in core inflation was broad based, with almost all segments declining compared to previous month. M-m data also shows benign momentum in core inflation and rise in food inflation. Health and education inflation still remains high, but has been on a steady decline since peaking in December. All other segments of core inflation are quite benign. Increase in food inflation driven by vegetables, meat, sugar and pulses. Urban-rural divergence continued in inflation and was the only jarring note in an otherwise good data, with rural inflation at 1.9% YoY and urban at 4.5%. Overall the number remains quite benign and with core inflation in steady decline prospects of further rate easing remains quite bright. Recent announcement of moderate MSP hikes, fiscal prudence in budget and improvement in monsoon should aid in keeping inflation under check.
FY20 Union Budget ticks most of the right boxes with government sticking to fiscal target belying fear of fiscal slippage amidst growth slow- down and faltering tax collection. Fiscal deficit target was reduced to 3.3%, compared to 3.4% in the interim budget. Budget also reiterated commitment of achieving deficit at 3% of GDP by FY21 signalling prudence over populism, and continuing with the theme of Economic Survey of reviving private investment.
There was some fear in the market about possibility of fiscal expansion but the budget has chosen to stick to fiscal consolidation. Moreover, fiscal targets have been budgeted to be achieved through higher receipts (both tax and non-tax) and not expenditure compression. Extra budgetary borrowing by the PSUs have also been reduced and overall Internal and Extra Budgetary Resources (IEBR)comes down from 3.25% to 2.5% of GDP. Overall the fiscal deficit number appears to be largely achievable. While we see some possibility of slippages in receipts, the same will likely be compensated through expenditure compression/roll over.
Higher taxes have been budgeted on the back of increase in custom duty in a range of items, increase in excise duty in petroleum and higher surcharge in personal income tax. Non tax receipts are budgeted higher in divestment and RBI dividend. Budget also announced measure to support NBFC sector which shall help in preventing contagion, and also announced more capital allocation for the PSU banks. In another major development for the bond markets, Government also announced that some part of its borrowing would be raised through external borrowing in foreign currency.
The budget reinforces the signal coming from Economic Survey that growth revival envisaged by the policy-makers is not through a short term boost to consumption or at the expense of macro stability. Government shall be sticking to fiscal prudence, while monetary policy is expected to do most of the heavy-lifting to revive growth and investment through structural reduction in cost of capital. The budget and the Economic survey focussed a lot on cost of capital and tried to explore ways to bring it down. The government it seems to us is doing more than what is required of it to bring the cost of capital down and if macro-economic environment globally and locally remains supportive then we can see it coming lower through follow up actions from RBI and the markets.
We expect RBI to continue with further monetary easing with government sticking to the fiscal targets, low hike in MSP, growth slowdown, benign inflation and positive global backdrop for rates. With gross borrowing number remaining same, borrowing in second half can be possibly lower by 100K from domestic markets. This is likely to reduce auction size to 12K from current 17K per week which can be financed quite comfortably.
The budget and the previous economic survey focused on bringing down the cost of capital, which would mean both baseline curve and good credit quality spreads coming lower. This would imply greater re-investment risks to investors as the government’s intentions starts to reflect itself in markets. We would thus suggest investors to be at the upper end of their duration risk appetite in their portfolio allocation. Investors with medium risk appetite could take advantage of spread compression and surplus liquidity environment to invest in funds focused on AAA corporate.
CAD: Current account deficit; NONG: Non-Oil, Non-Gold; BoP: Balance of Payment; NBFC: non-banking finance companies; PSU: Public Sector Undertakings Source: CEIC, Bloomberg, RBI
Source: CEIC, Bloomberg, RBI
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