Aditya Birla Sun Life Mutual Fund

Investment Outlook - Debt Market - March 2020

Mar 13, 2020
4 mins | Views 11369
Mr. Kaustubh Gupta

Growth indicators

India quarterly GDP for the third quarter declined to 4.7%, from the revised 5.1% (4.5% earlier) growth in 2Q FY20. The low growth is largely on the back of steep contraction in GFCF while consumption remained relatively decent. Both exports and imports growth were negative. There was a series of revisions in the GDP numbers with 1Q and 2Q growth, with both quarter growth revised up 0.6%. As a consequence of revisions, ytd GDP growth stands at 5.1% now, compared to FY19 growth of 6.2%.

GVA growth declined to 4.5%, compared to 4.8%. The weakness is largely due to dismal 0.1% growth in Industry with both manufacturing and electricity contracting. Growth in services was relatively decent at 7.4%, with heavy lifting done by Public administration defense and social services (PADS) (reflection of strong government expenditure. GVA ex PADS was worse at 3.7% y-y.

Most high frequency indicators (except PMI and recent data in electricity) continued to point to weak growth, although some pick-up is visible compared to extreme weakness witnessed in August to October period. IIP remains weak and December IIP re-entered negative zone, although it’s still the second highest in last 5 months suggesting some stabilisation. Manufacturing was disappointing at -1.2% with 7 out of 23 groups showing positive growth. Auto sales remain disappointing with close to double digit contraction. However, there is some pick-up in freight and transport data. Credit growth remains disappointing.

External sector

Exports growth in January remained weak, while imports growth improved, although still remained in negative zone at, suggesting some stabilisation in external trade, although still weak (more macro indicators pointing to some stabilisation, although still weak growth). Uptick in imports was both on the back of higher oil imports, which should reverse in February given fall in prices, and also, improvement in NONG imports which is somewhat encouraging though still in negative zone. Trade balance jumped to a normal level of US$15.2 bn after being in 11-12 bn zone for last 5 months.

However, services trade remained decent in December with services exports and imports growing, resulting in a record high trade surplus of US$ 7.4 bn. Overall (service + merchandise) trade balance for 4QCY19 stood at (-)13.5 bn USD, compared to (-)19.4 bn in 3Q and (-)30.3 bn in 4QCY18, hinting at near balance CAD (0 to 3 bn USD of CAD) and healthy BoP surplus, which had been reflecting in strong forex accretion.

Inflation

January inflation remained elevated, with broad basing of inflationary pressure and headline inflation rising once again to 7.6%, second month above RBI target inflation zone. The uptick was led by pickup in core inflation to 4.16% as well as in fuel and light inflation. Food inflation eased but remained elevated at 13.6% from 14.2%. Vegetable inflation which has been a key driver to high inflation has eased in February and commodity prices have also collapsed following the coronavirus scare. We thus expect inflation to ease in upcoming readings.

Impact of Coronavirus

Coronavirus has emerged as a key threat to global economy and markets. The increase in number of infected cases has been very rapid across the globe, affecting 109 countries and territories around the world with 1.1 lakh cases and 3830 deaths. With quarantine found to be the only effective way to contain disease till now, the diseases has led to sharp decline in economic activity in effected countries.

In the current quarter global growth is likely to be severely impacted. China, which was the first majorly effected country, and which implemented quite extreme quarantine measures to contain the disease, has witnessed sharp decline in economy activity with composite PMI for February declining to record low of 27.5. Other high frequency activity data from China is also reflecting a significantly negative growth, but there will be policy reactions, which may somewhat limit the impact. But a positive growth in China in this quarter still looks unlikely. Besides China, growth impact is likely to be high in other major hotspots viz: South Korea, Europe (particularly Italy), Iran, and economies highly dependent on tourism. Global growth impact is expected to be severe and high probability that global growth in 2020 will be the worst at since global financial crisis and likely less than 2%, contrary to expectations of rise in growth, only a few months back. Impact on global supply chain will start impacting industries far and wide. The epicentre of Virus: China, South Korea and Japan is deeply integrated to global supply chains and the effects will be far and wide. Impact on services and consumer confidence which has been the lynchpin of global growth in the last 18 months is a big risk. Airlines, hospitality, commodities, electronics and pharma, are likely to be severely impacted.

Global markets are in severe risk-off mode with sharp fall in global equities and bond yields declining across the world, with US bond yields declining to record lows. Fed has responded with a mid-policy 50bp rate cut, but markets remain unsettled and volatility remains high. India is unlikely to escape unscathed from the impact of coronavirus. While the number of cases so far has been low, risks remain high and one cannot rule out the policy of undetected cases. Even without a sharp rise in cases, growth is likely to be negatively through impact on supply chain, weakness in equities, FII sell-off and overall tighter liquidity conditions. Overleveraged companies of vulnerable sector may also feel stress. However, the fall in crude prices should provide some relief.

Portfolio positioning

Given global economy is likely to slow down substantially and path to recovery remains uncertain, it is likely that even RBI will ease rates in next policy meeting and may use other tools like Long Term Refinancing Operations (LTROs)to calm the anxiety of markets. Thus, we have increased duration across our funds and have reduced the credit exposure incrementally. Given the various probable scenarios, Banking & PSU fund and corporate bond funds which invest predominantly in AAA PSU papers looks the best risk adjusted strategies.

CAD: Current account deficit; BoP: Balance of Payment; Source: CEIC, Bloomberg, RBI

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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