Insights INSIGHTS

From old risk to new

The year 2020 started on a positive note with the US and China signing the Phase One trade deal on 15 January,
after nearly 18 months of trade animosity. The US pledged to reduce tariffs on USD 120 bn of Chinese imports
from 15.0% to 7.5%. China reciprocated by halving the tariffs on US imports worth USD 75 bn. The cut in tariffs
by both the countries will be effective from 14 February. Alongside, the UK officially exited from the European
Union on 31 January, three-and-a-half years after the public vote to leave the EU. The two neighbors have now
entered the transition phase which lasts until the end of this year. This implies the period of uncertainty
remains till the two sides reconcile the terms of trade.

In the midst of a watchful eye on such events, the novel coronavirus (2019-nCoV) outbreak was declared as a
global health emergency by the World Health Organization. The coronavirus which had its origin in China’s
Wuhan province has spread to nearly 31 countries with 1016 people reportedly dead from the virus in China.
This is likely to post some near-term challenges to the anticipated global economic growth recovery.

In terms of the economic impact, trade and tourism are directly impacted from the coronavirus spread. Travel
restrictions including quarantines are accelerating at a global level to restrict the spread of the virus. The
indirect impact to the global economy stems from the disruption of supply chains. While China has stepped
up efforts to prevent any financial meltdown in the mainland however the closure of industrial activity amidst
extension of Lunar New Year holidays is likely to postpone China’s economic growth recovery alongside that
of the global economy. The fear of this has already started shaping up in the commodities market with the
global oil prices trading at nearly 16.0% low of USD 54.0 per barrel month-to-date. Reportedly, OPEC+ is
considering crude output cut of 600,000 barrels per day to offset the muted demand resulting from the impact
from the coronavirus on industrial activity.

On domestic front, the government released the FY21 Union Budget where they invoked the escape clause to
revise FY20 fiscal deficit higher to 3.8% of GDP vis-à-vis the initial target of 3.3%. The government further
expects a lower fiscal deficit target of 3.5% in FY21. While the overall arithmetic appears broadly credible, the
attainment of FY21 fiscal deficit target hinges on realizing record high disinvestment target along with
substantially higher telecom revenue. On the data front, lead indicators for the months of December-January
show an improvement vis-à-vis the previous month. Overall, for FY20, we expect GDP growth at 4.9% GDP
vis-à-vis the official estimate of 5.0%. On inflation, we expect average CPI inflation to remain above 6% between
Q4 FY20 and Q2 FY21, before cooling off to 3.0-3.5% range in H2 FY21. As such, we continue to expect an
extension of pause on repo rate until H1 FY21. Thereafter, with inflation slipping below 4% and output gap
persisting in the negative territory, the MPC is likely to opt for a 25 bps rate cut in Oct-20 policy review..

Dhavan Shah
Shubhada M. Rao
Chief Product Officer,
Chief Economist
Product and Program Management

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Global Macro Developments

Britain’s senior minister Michael Gove said that Britain plans to introduce import controls on EU goods at the
border after its post-Brexit transition period ends on 31st Dec this year
The US and China signed the first phase of a trade deal on Jan 15. The deal stipulates that China will buy USD
77 bn in additional goods and services in 2020 and USD 123 bn in 2021 to meet the total USD 200 bn. Recall,
China had bought USD 186 bn of US goods and services in 2017
BoJ board member Takako Masai said the global economy is on track for a rebound around mid-year as
manufacturing activity picks up, signaling that risks such as the coronovirus outbreak do not warrant an
immediate expansion of stimulus
In a bid to cushion the epidemic’s economic blow, China injected CNY 1.7 trillion (USD 242.74 billion) via
reverse repos, helping Chinese stocks reverse some losses and lifting the world equity index.
Malaysian government officials said that India’s move to cut back on palm oil purchases is “temporary” and
will be resolved amicably between the two nations
The Fed, in a unanimous decision, decided to keep interest rates unchanged at 1.5% to 1.75% on the back of
sluggish pace of inflation coupled with a strong labor market
The ECB, in its first-rate decision of the year, voted unanimously to keep the main deposit rate at -0.5%, in line
with market expectations
The IMF said that the global economic outlook remains sluggish as it trimmed its growth forecasts for 2019
and 2020 to 2.9% and 3.3%, respectively. Both figures are down compared with forecasts in October, and it
marks the IMF’s sixth straight reduction for 2019

Events and Data Calendar

COMMODITY

Gold prices increased by 5.2% MoM in January vs. an increase of 0.6% MoM in December driven by
heightened uncertainty after the coronavirus outbreak.

Brent prices contracted by 3.4% in January vs. an increase of 5.0% in December on concerns over the
economic impact of the spread in coronavirus

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Domestic Market Macro Economics

India’s Manufacturing PMI recorded close to an eight-year peak of 55.3 in January from 52.7 in December, led
by sharp improvement in domestic and external demand conditions leading to new business orders, output
demand, export orders and increase in employment.
India’s Services PMI recorded a seven-year peak of 55.5 in January from 53.3 in December led by better
domestic demand conditions especially from the consumer services industry.
After contracting for four consecutive months, growth in core sector finally turned positive clocking 1.3% YoY
vis-à-vis a contraction of 0.6% YoY last month. Except crude oil and natural gas, all other six sectors within
the core index have showed growth as against the Nov-19 print
Fiscal deficit for Apr-Dec FY20 stood at 121.5% of full year’s revised estimate. Despite relatively higher
traction in non-tax revenues in FY20 so far, the higher FYTD accumulation of fiscal deficit is a reflection of
lower than expected tax revenue collection, slow progress on disinvestments, and a relatively healthy pace of
expenditure.
Non-food bank credit growth continued to hover close to 2-year low levels in December with annualized print
coming in at 7.1% vis-à-vis 7.8% in November.
India’s CPI inflation in Dec-19 accelerated to a 65-month high of 7.35% YoY from 5.54% in Nov-19 led by
increase in food prices coupled with partial incorporation of increase in prices for few generic drugs and
telecom tariffs.
India’s industrial production recovered from a contraction recorded in previous three consecutive months,
coming in at 1.8% YoY in Nov-19 vis-à-vis a contraction of 4.0% in Oct-19, aided by expansion in Mining and
Manufacturing sector along with support from a favorable statistical base

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We expect:
We foresee FY20 GDP at 4.9% vis-à-vis the official estimate of 5.0%. With H1 FY20 growth printing at 4.8% we
expect sequential recovery with average growth in H2 FY20 coming in at ~5.1% on account of favorable
statistical base along with factors like positive monsoon outturn, improved Rabi sowing, recent shift in terms
of trade in favor of farm sector, and higher budgetary allocation for the rural sector in FY21
We expect average CPI inflation to remain above 6% between Q4 FY20 and Q2 FY21, before cooling off to 3.0-
3.5% range in H2 FY21

Equity Market Insights

The equity market rally turned broad-based in January. Small caps significantly outperformed large caps with
the Nifty Small Cap 100 rising 6.7% for the month versus a 1.7% fall in the Nifty. Similarly, Nifty Mid Cap 100
rose 5.3% outperforming the Nifty by 7%.
This is in line with our view of the past few months that the extreme polarization that the market had witnessed
in favour of selective large caps should continue to reverse as a revival in economic activity an corporate profits
materializes going ahead.
Union Budget for FY21 was presented on February 1 and was aimed at reviving growth by attracting foreign
flows through equity and debt. Given the need to revive growth, Fiscal Deficit target for FY20 was revised to
3.8% of the GDP Vs. 3.3% estimated earlier. The growth estimates (GDP estimates) for the upcoming fiscal, too,
brought little cheer to the markets

Outlook & Expectations

In the absence of market friendly measures in the budget and given the cautious global environment owing
to the spread of Coronavirus, markets could stay volatile in the near-term. However, eventually markets
should move back to focusing on corporate earnings.
The earnings yield of equities is attractive and supportive of high valuations. A bearish outlook on oil and
commodities in general also upholds India’s case. The fag-end monsoon onslaught, which fetched an excess
to the tune of 110% of long-term averages, augurs well for the next Rabi crop.
In our view, significant easing in financial conditions, both locally and globally, improving prospects for the
rural economy given increase in food prices and better acreage, and various measures taken by the
government so far should bring about an improvement in both economic activity and corporate earnings
going forward.
To offset the expenditure burden, GOI seems intent on fast-tracking disinvestments which augers well for the
markets.
As the key index inches upwards, allocation to large caps makes sense at this juncture. But we also note that
consumption is in a cyclical downtrend now, the economy has slowed, liquidity issues remain and the
Budget didn’t particularly excite either. Therefore, we believe that a systematic withdrawal (SWP) approach
is equally warranted. A staggered approach to investing would be a better one, given the present state of
equities.

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Debt Market Insights

The average systemic liquidity maintained a surplus of INR 3,182 bn in January vs. a surplus of INR 2,631 bn
in December.

The average 10yr G-sec bond yield decreased to 6.58% in January from 6.63% in December amidst prevalence
of surplus money market liquidity, outright OMO purchases and Operation Twist by the RBI.

We expect average CPI inflation to remain above 6% between Q4 FY20 and Q2 FY21, before cooling off to 3.0-
3.5% range in H2 FY21. As such, we continue to expect an extension of pause on repo rate until H1 FY21.
Thereafter, with inflation slipping below 4% and output gap persisting in the negative territory, the MPC is
likely to opt for a 25 bps rate cut in Oct-20 policy review

Outlook and Expectations

We see money market liquidity to be in surplus mode in the near term

Absence of additional borrowing in FY20, as indicated in Budget FY21, are supportive of market sentiment

For FY21, the net G-sec borrowing is budgeted to increase to INR 5.45 tn from INR 4.74 tn, while T-Bill
financing in quantum terms is expected to remain unchanged at INR 250 bn

Prevalence of surplus money market liquidity and the introduction of Operation Twist by the RBI will lower
the upside risk to domestic yields. Hence, despite the expectation of monetary policy pause until H1 FY21
and fiscal slippage, we expect 10Y G-sec yield to trade in the 6.3-6.7% range until Sep-20

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Glossary
Consumer Price Index (CPI): A measure that examines the weighted average of prices of a basket of
consumer goods and services, such as transportation, food and medical care.
Wholesale Price Index (WPI): An index that measures and tracks the changes in price of goods in the
stages before the retail level.
Open Market Operations (OMO’s): is the buying and selling of government securities in the open market
in order to expand or contract the amount of money in the banking system. Purchases inject money into
the banking system and stimulate growth while sales of securities do the opposite.
Cash Management Bills (CMB): A short-term security sold by RBI to meet any temporary shortfalls.
Purchasing Managers Index (PMI) is based on surveys on private sector service /manufacturing
companies. An index level of 50 denotes no change since the previous month, while a level above 50 signals
an increase or improvement and below 50 indicates a decrease or deterioration.
Net Demand and Time Liabilities (NDTL): It is the sum of demand and time liabilities (deposits) of banks
with public and other banks wherein assets with other banks is subtracted to get net liability of other
banks.
Current Account Deficit (CAD): A measurement of a country’s trade in which the value of goods and
services it imports exceeds the value of goods and services it exports. A current account deficit represents
negative net sales abroad. A country can reduce its current account deficit by increasing the value of its
exports relative to the value of imports.
West Texas Intermediate (WTI): also known as Texas light sweet, is a grade of crude oil used as
a benchmark in oil pricing. This grade is described as light because of its relatively low density,
and sweet because of its low sulfur content.

For Further Information on Model Portfolios, kindly contact your Relationship Manager.

Vineet Dhar
Radhika Piplani and Sanjana Shah Shubhada M. Rao Group President and Head
Economist Chief Economist Wealth & Channel Management
radhika.piplani@yesbank.in shubhada.rao@yesbank.in vineet.dhar@yesbank.in
sanjana.shah@yesbank.in
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