May 5, 2011

April turned out to be a lacklustre month for markets with nifty being down 1.4%. FII investments continued in April with a total amount of 7000 crore invested in addition to the 7,000 cr invested in last week of March. There has been a net inflow of around 5000 crores by FIIs so far in this calendar year.

RBI announced the annual policy for FY12on 3^rd May. Policy actions undertaken are as follows:

· Repo Rate increased by 50 bps to 7.25%

· Reverse repo to be now a derived value fixed at 100bps discount to Repo. The new rate is 6.25%

· MSF, a new programme for banks to borrow overnight from RBI, with the rate fixed at 100bps premium to repo rate (8.25%).

· Savings Rate increased by 50 bps from 3.5% to 4%.

· Provisioning requirement for certain non-standard assets increased.

All the measures combined could lead to margin compression for the banking space. The savings rate hike would lead to a 12-13bps pressure in banks margins. So far, demand for both industrial and consumer credit has held on quite well. However, if demand softens, banks may not be able to fully pass through interest rate hike to clients resulting in further margin pressures. Also, higher interest rates might lead to NPL creation. There could be some pressure on Capital Goods space as cost of capital increases and the order inflow activity slows down. Home loans would become expensive.

The tone of the policy was clearly hawkish. RBI stressed on managing inflationary expectations as its number one priority. It expects the high crude oil and commodity prices to sustain at these levels and even gain going forward. RBI has forecasted the Fy12 growth at 8%. There could be downside risks to that if infrastructure and manufacturing activity slows down further. RBI also expressed concern about the ongoing fiscal consolidation with the budgeted crude oil and fertilizer subsidies being clearly insufficient. This might lead to enhanced government borrowing programme in H2 FY12 putting further upward pressure on bond yields.

We would expect a GDP growth of 8% for this year which would be slightly lower than FY11. The reviving global economic growth augurs well for Indian IT and Metal companies. Also, we believe that consumption stays strong and with the expectation of a good monsoon, discretionary consumption should stay buoyant.

The earnings season is on and most of the companies have come out with inline results for Q4 FY11. While banks have generally delivered a good set of numbers, companies in Oil and gas and cement space have disappointed. Some pressure in margin is visible for engineering and construction companies due to increase in commodity prices and rising interest rates, but that should get compensated by the increase in earnings of Metal companies. We expect a steady earnings growth of 17-18% for Nifty as a whole for Q4 FY11.

While we remain concerned about rising interest rates & high crude oil prices in the short term, we continue to expect a robust earnings growth of 20% for FY12 which will drive equity market returns in the medium to long term. The market looks inexpensive and is trading at 14-15 times FY12 and 12 times FY13 earnings. After the recent correction in banking space, we believe valuations have become attractive. We prefer private sector banking names as they fare better on asset quality issues vis-à-vis their PSU peers. Also, sectors like Information Technology, Healthcare which are relatively lesser impacted by interest rate and inflation risks, should do well going forward.