J.P. Morgan - India Equity Strategy

India Equity Strategy RBI Credit Policy - A Few Positive Surprises

In the bi-monthly policy review announced early today (http://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=31329), RBI left the key rates unchanged, in-line with our and consensus expectations.

Consequently the repo rate, reverse repo and the penal Marginal Standing Facility (MSF) rate were left unchanged at 8%, 7% and 9% respectively.

But there were a few positive surprises:

1. The Statutory Liquidity Ratio (SLR) was reduced by 50 bps to 22.5% of Net Demand and Time Liabilities (NDTL). The Banking system on aggregate currently maintains SLR close to 30%, so this is not a binding constraint. That said, the move seeks to improve credit availability to the private sector as the economy recovers and loan growth picks up. Indirectly, the measure expects the Government to continue on the fiscal consolidation path and consequently need lower funding and market borrowing.

2. Expectations on growth and inflation remain unchanged. But the tone of the policy is on the margin a tad more dovish (please refer to key statements below).

3. Also, in line with prior expectations, the RBI has eased the limits on overseas remittances (from US$75,000 to US$125,000 per annum), indicating an improved outlook on INR.

Key forecast statements:

· On Inflation - The Reserve Bank remains committed to keeping the economy on a disinflationary course, taking CPI inflation to 8 per cent by January 2015 and 6 per cent by January 2016. If the economy stays on this course, further policy tightening will not be warranted. On the other hand, if disinflation, adjusting for base effects, is faster than currently anticipated, it will provide headroom for an easing of the policy stance.

· In April the policy statement read - Our policy stance is firmly focused on keeping the economy on a disinflationary glide path that is intended to hit 8 per cent CPI inflation by January 2015 and 6 per cent by January 2016. At the current juncture, it is appropriate to hold the policy rate, while allowing the rate increases undertaken during September 2013 through January 2014 to work their way through the economy. Furthermore, if inflation continues along the intended glide path, further policy tightening in the near term is not anticipated at this juncture.

· On Growth - Contingent upon the desired inflation outcome, the April projection of real GDP growth from 4.7 per cent in 2013-14 to a range of 5 to 6 percent in 2014-15 is retained with risks evenly balanced around the central estimate of 5.5 per cent

Market reaction:

· The Bond markets perceived the guidance to be dovish. Consequently short-rates (1Y, 2Y, 5Y OIS) have fallen between 10-14 bps and the 10-Y bond yields have also softened 8 bps.

· Our Economists have however cautioned that markets run the risk of over interpreting the RBI’s guidance as being dovish and have ruled out rate cuts for the foreseeable future (please refer RBI expectedly on hold but markets risk over-interpreting future guidance, June 3, Sajjid Chinoy).

· The INR depreciated by ~ 0.3% to 59.3 vs. the USD.

· The performance of Equities was mixed.

o While the NIFTY is up 0.7%, the performance has been driven by Resources - Metals, Energy and Cement.

o The Bank NIFTY is down 0.2%. But this performance has to be viewed in the backdrop of the sharp up move yesterday.

Portfolio Stance

· Given the nature and extent of challenges facing the economy, we expect the recovery in the economy and corporate earnings over the near-term to be relatively muted in relation to current elevated market expectations.

· Consequently, we would avoid companies with high leverage or where expectations of a turnaround are premised on regulatory / political largesse. We would particularly caution against chasing beta in the financials (State Owned Banks and NBFCs) and investment cycle space (private sector infrastructure conglomerates).

· Since the beginning of the year we have been advocating playing a potential economic recovery through high-quality Financials, Commercial Vehicles, Cement and Resources – Metals and Energy.

· We believe any policy reform by the incoming Government to kick-start the investment cycle will initially have to start with the Resources sector. Reforms herein will be key to resolving bottlenecks in the Infrastructure sector and subsequently the Credit cycle in the financial sector. Note that Energy and Metals have been among the best performing sectors in the beta rally over the last few months.

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