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Dear Investors,

Equity Markets continued to rally, registering further gains of 1.4% during the month of April. Year to date BSE Sensex is up by 15% and are at all time high levels. FIIs turned net sellers in April after strong buying in March with USD 171mn of net outflows. Mutual Funds were buyers in April with net inflows of USD 1.5bn vs sellers last month. Strong domestic flows and favourable monsoon forecast helped sustain market rally.

Industrial production in February contracted by 1.2% led by manufacturing sector, which reported a decline of 2%. Electricity output increased at a muted pace of 0.3%. Mining output increased by 3.3% but lower than what was seen in January. Consumer output is the biggest drag on industrial output as it declined by 5.6% in February compared with an increase of 0.5% in January. Consumer demand has been weak in H2, possibly due to demonetisation.

Headline inflation increased to 3.8% from 3.7% in February on the back of higher food inflation and pass-through of higher international oil prices into domestic prices. Food prices increased by 2.5% in March compared with 2.4% increase seen in January. The uptick in food prices is led by eggs and vegetables.  Core inflation increased to 4.9% led by pass-through of higher international oil prices into domestic retail prices. Notably, domestic retail fuel prices were reduced by 5% at the end of March and thus may lead to a lower core inflation print next month.

The Indian Meteorological Department (IMD) forecasts the southwest monsoon at 96% of Long Period Average (LPA) with a model error of (+/-) 5%. The LPA for 1951-2000 is 89 cm. The first estimate for southwest monsoon in FY 2017 was at 106% of LPA. By end of the season (June-September) monsoon was ~3% below normal. The IMD sees 38% probability of near-normal monsoon in FY 2018. Spatial and temporal distribution of monsoons may be available in the second update in June. Skymet, an independent agency, has forecast monsoon at 95% of LPA with 10% probability of above-normal rainfall, 50% of normal rainfall, 0% of excess rainfall, 25% of below-normal rainfall, 15% of drought.

In the April bi-monthly Monetary policy, RBI kept the repo rate and CRR unchanged. However, it surprised the market by hiking the reverse REPO rate by 25bps to 6% thereby narrowing the policy corridor to 25bps. The RBI stated that it is committed to moving liquidity from the current surplus towards neutral in the next three or four quarters. For now, the RBI will use market stabilisation scheme bonds, longer tenor term reverse repos and open market operations to drain excess liquidity. RBI increased its inflation projection to 4.5% (vs 4-4.5% earlier) in H1 and 5% (vs 4.5-5%) in H2 FY 2018. The GVA growth projection for FY 2018 kept unchanged at 7.4%. The RBI’s structural models project growth to rise to 8.1% in FY 2019 and inflation to reach 4.6% by Q4 FY 2019.

The policy is hawkish as the inflation projection is hiked along with increase in reverse repo rate.  The Monetary Policy Committee (MPC) acknowledged that Global as well as domestic growth outlook is improving. RBI is concerned about upside risk to inflation due to implementation of allowances of 7th Pay commission, implementation of GST and higher central and state government deficit along with farm loan waivers. The yield may harden as the policy is hawkish having concern on inflation. The additional system liquidity is likely to reduce in two to three quarters putting pressure on yield curve. The bond market may witness relief rally on lower CPI print and fiscal consolidation measures.

Markets have rallied over the last two months. Broad economic parameters and global liquidity and domestic flows are likely to sustain premium valuations despite the earnings inching up only gradually in near future. Current quarterly result season, further progress and implementation of GST, actual monsoon progress and Fed policy are some of the factors that one needs to closely monitor. We continue to remain constructive on equities.

Sanjay Chawla
Chief Investment Officer
Source: Bloomberg, Economic Times
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