2019 INVESTMENT STRATEGY REPORT - IndiaNotes
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INVESTMENT
STRATEGY REPORT
2019
INVESTMENT
STRATEGY REPORT
2019
Vivek Ranjan Misra
040 - 3321 6296
vivekr.misra@karvy.com
Karvy Stock Broking Research
is available on
Thomson Reuters &
Bloomberg (Code: KRVY)INDEX
Wealth Maximizer Table......................................................... 1
Value Invest Table................................................................... 1
Dividend Maximizer Table...................................................... 1
Market Outlook................................................................... 2-3
An Interview with Our CEO, Rajiv Singh............................ 4-6
2019 – A Year of Economic Optimism in India...................... 7
Equity Market - 2019 Outlook...........................................8-14
Sector Outlook................................................................. 15-18
Automobiles.................................................................................. 15
Capital Goods & Infrastructure................................................ 16
Metals and Mining.................................................................. 16-17
IT Sector......................................................................................... 18
Indian Economic Outlook................................................ 19-21
The Global Economic Outlook.........................................22-26
Wealth Maximizer ................................................................. 27
Bharti Infratel Ltd.................................................................. 28-29
HCL Technologies Ltd.......................................................... 30-31
Hindustan Unilever Ltd........................................................ 32-33
ICICI Bank................................................................................34-35
Larsen & Toubro Ltd............................................................. 36-37
Oil & Natural Gas Corp Ltd................................................. 38-39
State Bank of India Ltd.........................................................40-41
Tata Motors Ltd.....................................................................42-43
UPL Ltd.................................................................................... 44-45
Yes Bank Ltd...........................................................................46-47
Value Invest...........................................................................49
Bajaj Electricals Ltd............................................................... 50-51
Finolex Cables Ltd................................................................. 52-53
Jain Irrigation Systems Ltd.................................................54-55
K.P.R. Mill Ltd..........................................................................56-57
Menon Bearings Ltd.............................................................58-59
Relaxo Footwears Ltd.......................................................... 60-61
Sunteck Realty Ltd................................................................ 62-63
Take Solutions Ltd.................................................................64-65
The Phoenix Mills Ltd............................................................ 66-67
Visaka Industries Ltd............................................................68-69
Dividend Maximizer...............................................................71
Dividend Maximizer Outlook.....................................................72
Bajaj Corp Ltd...............................................................................73
Bharat Heavy Electricals Ltd.................................................... 74
Bharti Infratel Ltd........................................................................ 75
Graphite India Ltd........................................................................76
Hero Motocorp Ltd......................................................................77
Indiabulls Housing Finance Ltd.................................................78
Indian Oil Corp Ltd.......................................................................79
JK Tyre & Industries Ltd............................................................. 80
Multi Commodity Exchange of India Ltd............................... 81
Vedanta Ltd...................................................................................82
Disclaimer.............................................................................. 83WEALTH MAXIMIZER
Market Cap CMP* Target Price
Company Name NSE Symbol Sector Upside (%)
(Rs. Bn.) (Rs.) (Rs.)
Bharti Infratel Ltd INFRATEL Telecom 486 263 308 17
HCL Technologies Ltd HCLTECH IT 1335 958 1167 22
Hindustan Unilever Ltd HINDUNILVR FMCG 3944 1822 2138 17
ICICI Bank Ltd ICICIBANK Banking 2323 361 440 22
Larsen & Toubro Ltd LT Infrastructure 2018 1439 1700 18
Oil & Natural Gas Corp Ltd ONGC Oil & gas 1931 151 210 39
State Bank of India Ltd SBIN Banking 2631 295 347 18
Tata Motors Ltd TATAMOTORS Automotive 540 171 259 51
UPL Ltd UPL Chemicals 386 758 1004 32
Yes Bank Ltd YESBANK Banking 420 181 410 127
VALUE INVEST
Market Cap CMP* Target Price
Company Name NSE Symbol Sector Upside (%)
(Rs. Bn.) Rs.) (Rs.)
Bajaj Electricals Ltd BAJAJELEC Electrical Equipment 51 497 670 35
Finolex Cables Ltd FINCABLES Electrical Equipment 70 459 600 31
Jain Irrigation Systems Ltd JISLJALEQS Farm Machinery & Equipment 35 69 101 46
K.P.R. Mill Ltd KPRMILL Textiles 41 565 716 27
Menon Bearings Ltd MENONBE Auto Ancillary 4 79 120 52
Relaxo Footwears Ltd RELAXO Footwear 88 732 911 24
Sunteck Realty Ltd SUNTECK Real Estate 51 348 497 43
Take Solutions Ltd TAKE IT 22 148 226 53
The Phoenix Mills Ltd PHOENIXLTD Real Estate 85 557 735 32
Visaka Industries Ltd VISAKAIND Construction Materials 7 426 750 76
DIVIDEND MAXIMIZER
Company Name NSE Symbol Sector Market Cap CMP* D.P.S# D.P#
(Rs. Bn.) (Rs.) (Rs.) (%)
Bajaj Corp Ltd BAJAJCORP Consumer Staples 53 360 13.4 77.9
Bharat Heavy Electricals Ltd BHEL Industrial Electrical Equipment 265 72 2.3 54.0
Bharti Infratel Ltd INFRATEL Telecom 486 263 11.2 89.3
Graphite India Ltd GRAPHITE Electrical Equipment 151 770 56.7 31.8
Hero MotoCorp Ltd HEROMOTOCO Automotive 624 3123 109.9 58.0
Indiabulls Housing Finance Ltd IBULHSGFIN NBFC 362 849 48.8 41.2
Indian Oil Corp Ltd IOC Oil & Gas 1342 138 8.1 43.0
JK Tyre & Industries Ltd JKTYRE Auto Ancillary 24 104 3.8 17.7
Multi Commodity Exchange of India Ltd MCX Financial Services 37 733 29.4 90.6
Vedanta Ltd VEDL Metals & Mining 741 199 14.0 44.5
*As on Dec 28, 2018, M.Cap: Market Cap, DPS: Dividend Per Share, D.P: Dividend Payout, # Bloomberg Estimates
1 KARVY INVESTMENT STRATEGY REPORT 2019MARKET
OUTLOOK
Heading into 2019, we are in the midst of a debate about the prospects of the world
economy and whether a global recession is looming. While data certainly points to a
slowdown in growth, the Indian economy is resilient and we find ourselves relatively
optimistic.
The US yield curve has flattened and the spread between the 10 year yield and 2 year
yield is 19 bps, a negative spread (or an inverted yield curve) usually points to a recession
ahead. However, more than US, data from other parts of the global economy are weak.
Caixin Manufacturing PMI for China for December 2018 dropped below 50 (came in at
Vivek Ranjan Misra 49.7) the first contraction since May 2017. Similarly, the Eurozone flash PMI dipped to 51.4
Head of Fundamental Research
in December 2018 from 51.8 in November, the slowest pace of expansion since February
2016. Exports from Germany, the largest economy in the Eurozone were down 0.9% in
the recent quarter, while the imports have risen by 1.3%, Germany’s economy grew by
1.1% YoY for the third quarter 2018, last quarter Japanese economy declined by 0.6%.
However, not all is bad, in the US, consumer confidence is near an 18 year high, whereas
unemployment rate at 3.7% is at a 40 year low. This indicates that consumption will be
resilient as wages are likely to rise on account of a tight labor market. While the Chinese
economy is facing a period of weakness, continuation of the trade wars is a risk. However,
China has eased both monetary and fiscal policy. China has plenty of policy tools at its
disposal to counteract a slowdown; its FX reserves are USD 3.1 trillion, which gives it
flexibility in managing a slowdown.
Indian economy remains resilient. IMF forecasts growth for FY2019-20 to be 7.4%, which
is a strong number. What makes us optimistic about equities is that growth drivers are
changing from private consumption to investment in Q2FY2018-19; Gross Fixed Capital
Formation (GFCF) increased by 12.5% YoY recording the third consecutive quarter of
double digit growth.
This has implications for the equity markets, as corporate earnings are more dependent
on growth in capex. Earnings growth has been the missing part of the story for Indian
stocks and good corporate earnings growth should boost stocks. While liquidity in money
markets is a risk, we believe RBI is in a position to manage this risk.
Exhibit: Sensex
50000
40000
30000
20000
10000
0
2010
2000
2011
2001
2014
2004
2015
2016
2018
2005
2006
2009
2008
2013
2017
2012
2003
2007
2002
Source: Bloomberg, Karvy Research
2 KARVY INVESTMENT STRATEGY REPORT 2019Exhibit: Performance of Indian equities relative to peers
120
110
100
90
80
Jun-18
Jun-18
Feb-18
Feb-18
Sep-18
Sep-18
Oct-18
Oct-18
Mar-18
Mar-18
Jul-18
Jul-18
Jul-18
Dec-18
Dec-18
Dec-18
Nov-18
Nov-18
Aug-18
Aug-18
Jan-18
Jan-18
Jan-18
Apr-18
Apr-18
May-18
May-18
EM EM Asia AP x JP All country
Source: Bloomberg, Karvy Research
The resignation of the Governor of RBI was a negative development but quick appointment
of a new Governor helped, going forward the RBI may be less hawkish with regards to
monetary policy.
The major event risk for Indian markets is on account of elections. Unlike 2014, the political
outcome appears unclear. Due to an uncertain political outlook, 2019 may shape up to a
tale of two halves, equities moving sideways ahead of the elections. If the elections lead
to a formation of a stable, business friendly government, Nifty may end the year 2019 at
14,000.
Given this, we favour cyclical sectors, we prefer Banks, Capital Goods. Also growth should
boost Consumption Discretionary and Autos. State owned banks could be a dark horse
in 2019, on account of peak in NPL cycle, recovery of NPL’s via IBC and low valuations. A
broad based economic recovery will be supportive.
We believe that over the coming quarters, large caps are likely to do better. Mid and small
caps are likely to underperform until their valuations become attractive. We believe that
after mid 2019, with decent time correction, conditions may be favourable for mid and
small caps to perform well.
3 KARVY INVESTMENT STRATEGY REPORT 2019AN INTERVIEW WITH OUR CEO,
RAJIV SINGH
Q) What are the lessons for investors from 2018?
Firstly, volatility in markets has increased; over the last few years, volatility has been low
on account of the low interest rates, especially in the US, as the interest rate cycle has
turned, volatility regime is now normalizing. CBOE VIX often called the fear gauge was
unusually low; 11% at the start of 2018, this has increased significantly since then and
stands at 25%. Similarly, India VIX which bottomed at 12.7% at the start of 2018, is up
2.7x and is currently at 34%. Higher volatility is not necessarily negative; we can witness
sharper moves in either direction.
Rajiv Singh
CEO - Broking Business, KSBL
The second lesson is with regard to risk- geopolitical risk has risen; a couple of examples
come to mind, the first is the emergence of trade wars between the world’s two largest
economies, the US and China. A few days back, the market believed that there had been
a truce, but recent events like the arrest of Huawei’s CFO in Canada means this is still a
risk. Secondly, the threat of sanctions on Iran had led to a sharp escalation in oil price,
threatening to derail the global economy, thankfully the world stepped back from the
brink of this event.
Thirdly, themes that worked last year may not work this year. In 2017, Small and Midcaps
were a big theme, and the BSE Mid and Small cap index returns were a handsome 54%
outperforming Sensex which gave a 27% return. This theme disappointed in 2018, BSE
Mid and Small cap index declined by 20%, whereas Sensex increased by 5.9%. The lesson
is to constantly reevaluate the investment themes and be ready to make changes to your
portfolio.
Fourthly, watch out for changes in regulatory and tax regime, the (re)introduction of
Long Term Capital Gains tax in the budget for FY2018-19 is a negative for investors. While
at the time of introduction in February 2018, this was widely anticipated, investors who
bought equities at the beginning of the Bull Run certainly didn’t factor this in.
Fifthly, watch out for the global economy-during the 2008 global financial crisis, India
was impacted largely on account of the financial channel rather than the direct economic
impact. India has a current account deficit (2.9% of GDP in July-September 2008 quarter),
this deficit needs to be funded by capital inflows which make India vulnerable to direction
of global capital flows. Similarly, events outside India- rise in oil prices, strengthening of
the US dollar led to a 14% correction in Nifty between August and October 2018. Global
capital flows have a major impact on Indian asset markets. As we head into 2019, fears
of a global recession have risen, and while we believe a recession is unlikely in 2019, the
global economy may be slowing down. In the coming quarters, investors need to keep a
keen eye for economic data from China, Europe, Japan and US.
Q) What is your outlook for equity markets in 2019?
We believe that 2019 may be a year of two halves-the equity market is likely to move
sideways due to the overhang of the General Elections.
4 KARVY INVESTMENT STRATEGY REPORT 2019Election of a stable, business friendly government can provide the next trigger to equities.
As we enter 2019, there are a number of risks, as well as positive triggers. On the whole,
we believe the positives outweigh the negatives.
While the macro outlook for India has deteriorated somewhat, but still remains strong;
growth for FY2019-20 is expected to be 7.4%. Importantly, we believe growth will be led
by Capex. Gross Fixed Capital Formation (GFCF) increased by 12.5% YoY during Q2FY19,
the third consecutive quarter of double digit growth. This is important for equity markets
as it will boost corporate earnings which can sustain the next rally in equities. In the past
few years, corporate earnings growth has been poor and a turnaround in the earnings
cycle can sustain the next rally in equities. According to the recently released RBI’s
financial stability report, gross non-performing assets (NPA) of banks decreased from
11.5% in March 2018 to 10.8% in September 2018 and are expected to further decline to
10.3% by March 2019. This is positive for the economy and markets. Our target for Nifty
for December 2019 is 14,000.
Q) What are the risks for equities in 2019?
Domestically, the main risk is of an unfavourable election outcome. If an unstable coalition
were to come into power later this year, Nifty may decline to 9,000. The second risk is
on account of monetary conditions. Liquidity has tightened, and interest rate cycle has
reversed, not only in India but worldwide. Domestically this has impacted NBFCs and if
this impacts the flow of credit, it is a negative for markets. The US is tightening by two
means, firstly by raising interest rates, and secondly by reducing the size of its balance
sheet by USD 50 bn (quantitative tightening) a month. Tightening of monetary conditions
is among the reasons that have led IMF to downgrade world GDP growth forecast for
2019 to 3.7% from 3.9% earlier.
Much of the risks for 2019 are global in nature, many investors are fearful of a recession
in the global economy. Many attribute the decline in equities (US equities were down 19%
last week) to an imminent recession.
The yield curve (difference between 10 year and 2 year government treasury yield) in the
US has flattened trading at a spread of 19 bps, this has also heightened fears. Inversion
(when the spread is negative) is an indicator of a recession, but the yield curve, is yet
to turn negative. More than the US, data from China is worrying; Caixin Manufacturing
PMI dropped to 49.7 (below 50 implies contraction) and China is taking steps to counter
the slowdown by loosening policy. Similarly, data from Europe and Japan also point to
weakening. We believe that the world economy is set to slow, but we are not on the cusp
of a recession yet.
Downturn in equities is typically preceded by euphoria- right now caution abounds; it
is said that to make a bull market you need to climb a wall of worry. There are a lot of
worries around and the bull market may still have legs.
Q) Which sectors are the best bets for 2019?
We favour sectors that are geared to a recovery in capex cycle namely Banks, Capital
Goods. Banks should benefit from the increase in demand for credit as economic activity
picks up and Capital Goods should benefit from an increase in orders on account of
5 KARVY INVESTMENT STRATEGY REPORT 2019capex. An increase in economic activity should boost employment prospects and thus
discretionary consumption. We like Autos and Discretionary Consumption stocks. State
owned banks could be a dark horse in 2019 on account of peak in NPL cycle, recovery of
NPL’s via IBC and low valuations. A broad based economic recovery will be supportive.
Q) What about Crude- is it a risk for India as we head into 2019?
Global crude oil prices have been witnessing a roller coaster ride and have been quite
volatile for some time now. The price of crude oil plummeted from a high of ~$115/bbl in
mid-2014 to a low of ~$28/bbl in January 2016 and to $54-55/bbl now.
Prices of crude oil play a significant role in an economy and India’s growth story revolves
around the import of crude oil which amounts to nearly 30% of the total imports. India’s
macro-economic factors such as inflation, fiscal deficit and current account deficit have
improved many notches over the last couple of years, mainly due to falling crude oil prices.
A bit of background - The price of the Indian basket of crude oil crashed from US$ 113 per
barrel in May 2014 to US$ 50 in January 2015 and remained subdued. But oil prices surged
to $86 a barrel in November 2018, faster than expected as the Venezuelan economic
crisis and threats of sanctions on Iran led to a bigger production cut than intended and
targeted by OPEC and non-OPEC members.
However, in the last few weeks, oil prices have retreated on news that the US crude
production may rise and on expectations of weak demand growth. Despite the supply
cuts agreed by OPEC+, oil prices have remained subdued.
A $10 per barrel increase in the price of oil reduces growth by 0.2-0.3 percentage points,
increases WPI inflation by about 1.7 percentage points and worsens the current account
deficit by about $9-10 billion dollars according to Economic Survey 2018.A fall in crude
prices is thus positive for Indian economy as it will help boost economic growth. Politically,
this will also be helpful for the current government in the upcoming elections.
Q) What are your thoughts about the long term prospects for Indian economy?
According to IMF, India is likely to be the world’s fifth largest economy in 2019, with a size
of USD 2.95 trillion. Earlier in the year, the Indian government said that India is likely to
double its GDP by 2025 to cross $5 trillion.
The drivers of economic growth are well known, namely favourable demographics, a rising
middle class, as well as impact of economic reforms. There are a few hurdles though.
Firstly, India needs to carry out a number of difficult economic reforms, especially in the
areas of labor, agriculture, land. Secondly, it needs to cut red tape in order to boost ease of
doing business. Thirdly, privatization of PSUs is necessary and lastly, it needs to carry out
further fiscal consolidation. In addition to these, there are a number of long term issues
that need attention - the quality of workforce is not as high as it was in Asian “miracle
economies” due to lack of quality education in government schools. Healthcare needs
attention; lack of quality infrastructure in government hospitals is a big problem; The
issue of malnourishment needs to be tackled, 38% of the Indian children aged between
0-5 are malnourished, resulting in a definite and irreversible damage to their physical and
mental capabilities. The labor force participation rate remains low, especially of women
(27% according to estimates) needs to improve and government needs to adopt policies
to encourage their higher participation rate.
6 KARVY INVESTMENT STRATEGY REPORT 20192019 – A YEAR OF ECONOMIC
OPTIMISM IN INDIA
With the start of the New Year 2019, the equity market may lay focus on some important
economic events like Bank recapitalisation, populist measure if any in the Interim Budget,
farm loan waiver effects, GST collection trends, progress under the insolvency code
and interest rate trajectory. Based on the outcome of the recent State Elections and the
General Elections due in the first half of calendar 2019, the government is likely to focus
more on the rural and agriculture sector. Creation of jobs at an accelerated pace could
be one more focus area.
The market participants will watch out for earnings upgrade for companies following
Dr. Ravi Singh normalisation of economic conditions on account of GST modifications ahead of the
Head of Technical Research General Elections. While confidence about earnings growth is rising, the outcome of
General Elections will give a final direction to the Indian equity markets. The more stable
and sound the formation of the new government, the more stable and strong would be
the Indian markets performance and vice versa.
The PSU Bank recapitalisation along with the Bharatmala and Housing for All initiatives
by the government has multi-fold implications and can materially revive the capex
cycle with potential acceleration in housing, railways and defence, ultimately having a
multiplier impact on GDP. With the General Elections due in May 2019, government has
refocused on growth going by its recent actions of fuel tax cuts, changing import duty
on agri commodities, GST rate rationalisation, higher MSP hikes and bank recapitalisation
plan. Though coupled with near-term pain of higher fiscal deficit, these initiatives may
put India on an accelerated growth trajectory from FY19 onwards.
However, the biggest area of concerns would be the worsening of the macro factors like
delay in resumption of GDP growth, ongoing global trade wars, unexpected impulses of
the US government and sustained interest rate rise in developed economies. Liquidity
in the markets continues to be good especially from the domestic investors. FIIs could
reevaluate investing in India in a big way since the inflation is under control and the
economic growth is satisfactory.
The calendar year 2018 has been a marginal year for investors with the Nifty giving
3% return. Investors would do well to moderate their expectations for index returns in
calendar year 2019. We expect Nifty to face resistance around 11750 levels followed by
12000 levels for the year ahead. On the lower side, we expect 10000 levels as support
followed by 9000 levels in extreme cases. Banking, Pharma, OMCs, Cement and Infra are
some sectors to watch out for in 2019.
7 KARVY INVESTMENT STRATEGY REPORT 2019EQUITY MARKET - 2019
OUTLOOK
In 2018, Nifty returns were 3.2%, disappointing investors after a 28.6% return in CY2017.
However, over the last 5 years, investors have earned 11.3% in price returns.
Exhibit: Nifty Returns
100%
80%
60%
75.8%
31.4%
71.9%
28.6%
27.7%
40%
17.9%
54.8%
10.7%
39.8%
3.0%
36.3%
6.8%
3.3%
3.2%
20%
0%
-4.1%
-51.8%
-20%
-16.2%
2011 -24.6%
2000 -20.6%
-40%
-60%
2010
2001
2014
2004
2015
2016
2018
2005
2006
2009
2008
2013
2017
2012
2003
2007
2002
Source: Bloomberg, Karvy Research
We believe that despite some slowdown in economic momentum, investors should look
forward to decent returns from equities.
Caution sets the stage for returns
It is said that to make a bull market, you have to climb a wall of worry. Indian equities
have been in the midst of a bull market for a while. We still don’t see unfettered optimism
that would worry us. In fact entering 2019, we find investors getting cautious. This gives
weight to our theory that the bull market still has legs.
Cautions relating to the following, which we will examine in detail later in the text.
Fears of a global economic recession
Caution regarding evolution of Indian economy over the next two years
Political uncertainty
Concerns regarding interest rates and financial system
We believe these are valid concerns, and while data indicates a slowdown ahead, we
believe we are not on the cusp of a recession.
Significantly the euphoria (“this time it is different”) that precedes a major downturn in
equities is missing, in fact, caution abounds. We believe that caution going into 2019 is in
contrast to the optimism at the beginning of 2018.
Drivers for 2019
In terms of drivers of equities for 2019, we believe the following are important questions
which we will try to answer.
8 KARVY INVESTMENT STRATEGY REPORT 2019Will FII inflows resume into Indian equities: 2018 witnessed net FII outflows of Rs. 335 bn
(or USD 6.4 bn), this was the first year of outflows since 2008. The graph below shows
that FII flows have a strong correlation with returns.
Exhibit: FII Inflows and Nifty Returns
1500 90%
1000 60%
500 30%
0 0%
-500 -30%
-1000 -60%
2010
2000
2011
2001
2014
2004
2015
2016
2018
2005
2006
2009
2008
2013
2017
2012
2003
2007
2002
FII Inflow (Rs. bn)- (LHS) Nifty returns %- (RHS)
Source: Bloomberg, SEBI, Karvy Research
Besides global risk aversion, a number of elements can be the deciding factors for global
assets allocation - firstly, last year the attraction of US assets was high, we believe this
factor will wane going into 2019. In Q3 2018, S&P 500 earnings grew by 28%, for CY2018,
the EPS growth estimate is 20%, this largely reflects the boost to earnings growth on
account of tax cuts as well as better than expected financial performance. For CY2019,
expected EPS growth estimate is 8%, for emerging markets, consensus EPS growth
estimate is 7.4%. Indian earnings are expected to perform better, with EPS for Nifty
expected to grow by 22% for FY2019-20.
In the past 5 years, earnings growth has been disappointing, but we believe that factors
are in place for a recovery in corporate earnings, which we will detail in a later section.
This factor should make Indian equities more attractive.
Currency is also an important factor; strengthening of the US dollar, largely as US assets
were more attractive caused emerging market equities to decline. US Dollar is expected to
weaken as we head into CY2019, with Futures indicating US Dollar Index to decline by 2%.
This should be supportive of Indian equities. Rupee has a positive correlation with the
equity market and the relationship is statistically significant. This implies that equities
benefit when the Rupee appreciates and equity market outlook gets clouded when
the Rupee depreciates. Currency is not the only factor that impacts markets but other
factors too can outweigh the impact of the Rupee wherein during periods of turmoil in
currency markets, the relationship can be more significant.
Exhibit: Sensex returns vs Rupee
20.00%
15.00%
10.00%
5.00%
USD INR YoY %
0.00%
-5.00%
-10.00%
-15.00%
-20.00%
-25.00%
-100.0% -50.0% 0.0% 50.0% 100.0% 150.0%
Sensex YoY %
Source: Bloomberg, Karvy Research
9 KARVY INVESTMENT STRATEGY REPORT 2019We believe that while INR is still overvalued considering the Real Effective Exchange Rate
despite having depreciated against the USD, this is largely as over the last five years where other
currencies have depreciated more against the USD. We believe that excluding a significant rally
in oil prices, there are few reasons for the INR to perform poorly against the USD.
Exhibit: India Real Effective Exchange Rate
110
105
100
95
90
85
80
Jan-10
Jan-96
Jan-99
Jan-00
Jan-11
Jan-98
Jan-01
Jan-97
Jan-14
Jan-04
Jan-15
Jan-16
Jan-05
Jan-18
Jan-06
Jan-09
Jan-08
Jan-13
Jan-17
Jan-12
Jan-03
Jan-07
Jan-02
Jan-94
Jan-95
INR REER Average
Source: BIS, Karvy Research
The one drag may be valuations which do reduce the attraction of Indian equities while
growth and likely direction of currency movement makes Indian equities attractive. In
our assessment, FII flows are likely to return to India. Also, India remains one of the few
markets where growth is likely to hold up in 2019, making it more attractive.
Can Domestic institutions counterweigh FIIs: FIIs have had a significantly higher impact
on the direction of the market than domestic institutions, however, incrementally their
influence on the markets has increased.
Exhibit: FII vs DII inflows
1370
1,331
1060
1,293
1,113
1,094
750
974
908
843
278
262
717
440
676
184
188
529
371
130
-180
-37
-569
-568
-214
-735
-303
-490 -342
-800
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
FII Inflow (Rs. bn) DII Inflow (Rs. bn)
Source: Bloomberg, SEBI, Karvy Research
Exhibit: Cumulative FII vs DII flows since 2007
8000
7000 FII flows Domestic flows
6000
5000
4000
3000
2000
1000
0
Sep-17
Sep-12
Sep-07
Jul-18
Nov-16
Dec-18
Jul-08
Jul-13
Jun-11
Dec-08
Dec-13
Jan-16
Jun-16
Apr-17
May-09
Apr-12
Apr-07
Mar-10
Oct-14
Feb-18
Feb-08
Feb-13
Aug-10
Nov-11
Oct-09
Mar-15
Jan-11
Aug-15
May-14
-1000
Source: Bloomberg, Karvy Research
10 KARVY INVESTMENT STRATEGY REPORT 2019We believe this represents a long term structural change, as capital market instruments
represent a small part of savings for Indian households, but has increased in the last couple
of years. Also, overall investment in equities by households is still low by international
standards.
Exhibit: Household financial savings invested in capital markets
12%
10%
8%
6%
4%
2%
0%
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
-2%
Source: RBI, Karvy Research
Exhibit: Investment of savings of households in Equities
50%
48%
40% 44%
37%
30%
20%
20%
10% 15%
10%
6%
0%
India UK Japan Korea Singapore US Hong Kong
Source: RBI, Karvy Research
India is witnessing a significant demographic shift, where the dependency ratio (proportion
of working age population to total population) has not only become favourable, but the
trend is expected to continue for more than a couple of decades. Thus, we believe that
domestic institutions as well as direct investment in equities are rising representing a
structural change.
Exhibit: Working age population (%)
55%
53%
51%
49%
47%
45%
2015 2020 2025 2030 2035 2040 2045 2050 2055 2060
India World
Source: World Bank, Karvy Research
11 KARVY INVESTMENT STRATEGY REPORT 2019In the short term, high volatility in equities may be a dampener, and inflows to equities
from domestic investors may suffer. Nevertheless, this makes Indian equities less reliant
on FII. In fact we believe this is the reason why Indian equities have been resilient in 2018,
outperforming peers.
Exhibit: Performance of Indian equities vs peers (in USD)
180
160
140
120
100
Relative to EM Relative to AP x JP
Relative to EM Asia Relative to AC World
80
Feb-16
Feb-18
Feb-17
Nov-14
Aug-14
Nov-15
Nov-16
Aug-15
Aug-16
Nov-18
Aug-18
Nov-13
Aug-13
Nov-17
Aug-17
May-14
May-15
Feb-14
May-16
May-18
Feb-15
May-17
Source: Bloomberg, Karvy Research
Will high valuations be a drag: Indian equities are trading at high valuation levels by
historical standards, currently at 19.4x 12 month forward PE ratio. This is high and is the
one factor that worries us.
Exhibit: 12 month forward PER of Sensex
24
20
16
12
8
Jun-16
Jun-18
Jun-06
Jun-09
Jun-08
Jun-13
Jun-17
Jun-12
Jun-07
Dec-10
Dec-11
Dec-14
Dec-15
Jun-10
Dec-16
Dec-18
Dec-05
Dec-06
Dec-09
Jun-11
Dec-08
Dec-13
Dec-17
Dec-12
Dec-07
Jun-14
Jun-15
Jun-05
12 Month forward PER Average -1 SD +1 SD
Source: Bloomberg, Karvy Research
India has traded at a premium to peers, and continues to do so. Valuations have a
significant impact on returns as can be seen by this graph.
Exhibit: 12 month forward PER of Sensex vs subsequent performance
24 -100%
20
-50%
16
12 0%
8
50%
4
0 100%
Nov-16
Nov-06
Nov-09
Nov-08
Nov-13
Nov-17
Nov-12
Nov-07
May-16
May-06
May-09
May-08
May-13
May-17
May-12
May-07
Nov-10
Nov-11
Nov-14
Nov-15
Nov-05
May-10
May-11
May-14
May-15
May-05
12 month forward PER (LHS) One year subsequent return % (RHS) (Inverted scale)
Source: Bloomberg, Karvy Research
12 KARVY INVESTMENT STRATEGY REPORT 2019However, there are a few mitigating factors which may help overcome the negative
forces on account of valuation:
yy Low bond yields in India implies higher valuation multiples. These may persist on
account of increased financial savings of Indian households, fiscal consolidation,
lower inflation than historical trend and increased FII flows to debt market on account
of high real interest rates in India
yy Earnings cycle - we believe that after a number of years of disappointing growth,
corporate earnings are in the early stages of a recovery
Also, the premium to emerging markets is a bit higher than the past but Indian markets
are at a significant premium to Asia Pacific excl Japan.
Exhibit: 12 month forward PER of MSCI India vs Emerging markets
2.2
2.0
1.8
1.6
1.4
1.2
1.0
0.8
Jun-17
Jun-12
Jun-07
Feb-09
Sep-18
Sep-08
Sep-13
Aug-11
Jul-14
Mar-16
Dec-14
Jul-09
Dec-09
May-10
Aug-16
Nov-17
Nov-12
Nov-07
Oct-10
Jan-17
Apr-18
Jan-12
May-15
Feb-14
Jan-07
Apr-08
Apr-13
Mar-11
Oct-15
India relative to EM Average
Source: Bloomberg, Karvy Research
Exhibit: 12 month forward PER of MSCI India vs Asia Pacific ex Japan
2.0
1.8
1.6
1.4
1.2
1.0
0.8
Sep-18
Sep-08
Sep-13
Jul-09
Dec-09
Aug-16
Nov-17
Nov-12
Nov-07
Oct-10
Jan-17
Apr-18
Jan-12
Feb-14
Jan-07
Apr-08
Apr-13
Jun-17
Jun-12
Jun-07
Mar-11
Feb-09
Oct-15
Aug-11
Jul-14
Mar-16
Dec-14
May-10
May-15
India relative to AP x JP Average
Source: Bloomberg, Karvy Research
Exhibit: 12 month forward PER
2018 performance (%) Now Beginning of 2018 Recent peak
EM (16.6) 11.3 12.7 13.6
USA (6.2) 15.4 18.3 18.7
India 3.2 19.6 21 22
Source: Bloomberg, Karvy Research
13 KARVY INVESTMENT STRATEGY REPORT 2019Elections- the next trigger for equities: In our report “Elections: the next trigger for equities”
we have highlighted that for Indian asset markets, the major trigger will be the upcoming
General Elections. We expect some nervousness in markets ahead of the elections. We
wouldn’t extrapolate the results to General Elections as the Indian electorate can vote
differently in State Elections and General Elections. We believe markets will welcome
continuity in the form of a NDA (led by BJP) regaining power at the centre.
Though it is still early, opinion polls (which also indicated a loss for BJP in State Elections)
indicate that NDA (led by BJP) is likely to regain power with a reduced number of seats.
This scenario would be welcomed by markets.
If this were to be the outcome of the elections, we would expect an acceleration in
economic reforms. Also infra spending by the government is likely to pick up.
Exhibit: Sensex - General Elections
Elections Year (%) 6 M before Zero Day + 1 Week 6 M after 6 M Prior to 6 M later
1996 20.8 0.7 (3.6) (17.3) (0.1)
1998 (8.0) 2.7 (0.6) (19.6) (24.3)
1999 31.9 (0.2) 7.1 (1.9) 36.3
2004 8.3 0.8 (8.7) 17.6 20.5
2009 29.7 17.3 (2.6) 19.1 81.5
2014 17.2 0.9 2.4 15.1 37.5
Source: Bloomberg, Karvy Research
Exhibit: MSCI India relative to EM - General Elections
Elections Year 6 M before Zero Day + 1 Week 6 M after 6 M Prior to 6 M later
1996 4.2 1.1 (3.9) (15.7) (12.9)
1998 5.9 2.7 (3.9) 24.2 33.5
1999 18.5 (1.0) 6.1 (1.7) 20.1
2004 4.7 2.1 (7.6) (0.8) 0.6
2009 (1.6) 18.1 (3.4) (3.4) 8.9
2014 19.0 0.6 2.8 13.2 37.6
Source: Bloomberg, Karvy Research
Earnings pickup: Earnings have grown at 4% from FY2013-14 to FY2017-18, and have been
the missing puzzle for Indian equities. The reason we believe is quite simple - it is on
account of lack of capex. This may be about to change, as we describe later in the Indian
economic update.
This should help in the recovery of corporate earnings, especially in sectors that are
geared for capex - namely capital goods and banks.
14 KARVY INVESTMENT STRATEGY REPORT 2019SECTOR
OUTLOOK
AUTOMOBILES
The auto industry is nearing the next down cycle. However, as the industry is shifting
towards improvisation in technology and comfort, we think that there is more scope for
expansion. The major push is expected to come from higher infra spending both in rural
and urban areas. With major OEMs investing in capacity addition, product development
via new launches among various automotive segments indicate that demand is still
around. We expect buying to increase after elections and just before BS VI norms are
implemented. Also, better execution of Minimum Support Prices will act as a catalyst
for rural demand pick up. Among all categories of vehicles, Commercial Vehicles
(CV) reported 31% YoY growth during YTD FY19 owing to higher industrial activity and
3-wheeler sales grew by 25% YoY followed by 10% growth in 2-wheeler due to higher
personal consumption. On the flip side, passenger vehicles reported 5% growth lower
than the average 2-year growth of 8.5%. This is due to delayed festive demand and
increase in car prices.
Implementation of BS VI: Post 2020, only BS VI complaint vehicles can be sold in the
market. Many OEMs have already introduced such models. With this, the price difference
between petrol and diesel variants will increase. Currently, the price difference between
petrol and diesel vehicles could be between Rs. 1 Lakh and Rs. 1.5 Lakh. Post BS VI, diesel
vehicles may cost Rs. 2 to 2.5 Lakh more than that of petrol vehicles. MSIL (Maruti Suzuki
India ltd) is manufacturing both Euro-V and Euro-VI (BS V & BS VI) variants and to be BS VI
compliant, certain components like Diesel Particular Filter, Selective Catalytic Reduction
need to be added because of which the overall cost of the vehicle is expected to go up.
With this, we think that the demand for diesel cars may slow down and as an indication
to this, Maruti Suzuki is expected to re-organize its diesel engine assembly plant in
Gurugram.
The future of electric vehicles: In the electric vehicle space, we are still at the initial phase
of development where the country requires capital investment for battery charging
infrastructure and streamline procurement of lithium ion. Dominant OEMs such as TATA
Motors, Mahindra & Mahindra have already introduced electric vehicles and even MSIL is
pacing faster by setting up its own lithium ion factory in Gujarat. Therefore, incentivising
hybrid and electric vehicles could be the need of the hour if they are to be promoted
faster. We think that there is more to happen in the EV segment in terms of innovation
and design.
Effect on Auto Ancillary businesses as electric vehicles increase: Most of the car ancillaries
will continue to exist except for certain engine components (though there is a lot of
time for that to happen). Furthermore, as safety regulations are being implemented,
demand for sensors, airbags, IoT (controllers), clusters, etc. may subsequently increase
as components per vehicle go up. At this onset, most auto ancillary companies have
technological collaboration with global makers for technical expertise. We think that
ancillaries with high product diversification especially in the new-gen technology will
benefit largely from this shift.
15 KARVY INVESTMENT STRATEGY REPORT 2019CAPITAL GOODS & INFRASTRUCTURE
Q2FY19 has been a real surprise for the investors with ~19% earnings growth in capital
goods index aided by some positive performances from L&T, BEL and Graphite India.
Post the earnings season, profits for CG index is revised upwards by ~3.4% for FY19E
and 1.0% for FY20E in view of reviving optimism in the sector. Companies like L&T,
Siemens, ABB, Kalpataru have reported a strong growth in order book. Further to add,
recent management commentary signaled a sense of positivity in near to medium term
aided by multiple government initiatives providing the necessary levers for sustained
growth. Industry is also of the positive view about the outlook for domestic sales as
underlying demand remains positive due to investments by the government in creating
infrastructure.
Of late, the sector witnessed a sluggish performance due to high interest cost, land
acquisition issues, over capacity in certain segments like power generation; however, it is
showing signs of recovery. Gross fixed capital formation in terms of GDP at Q2 of 2018-
19 was estimated at 32.3% compared to 30.8% in Q2 2017-18. The investment by both
government and private sector has picked up as new projects have been announced.
The industry capacity utilisation has increased to 73.8% in Q1FY19 from 71.2% in Q1FY18.
The IIP-based capital goods index was strong during the April-October period at 8.7%
compared to 0.7% in the corresponding period of previous financial year indicating a
decent performance in FY19 & 20.
On construction front, while the government has been taking efforts ranging from
increased budgetary allocations to higher road project awarding, funding has been an
issue. Of the 64 HAM projects awarded till now in 2018, around 30 projects have not
achieved financial closure yet. Among the ones that received FC, some projects have
exceeded the stipulated time line of 5 months to achieve FC indicating the issues from
bank’s perspective. The pace of road construction also slowed down in H1FY19 as issues
related to land acquisition cropped up. Under HAM, bank funding is available once 80% of
land is acquired. Further to add to the woes, existing developers have their hands full with
significant orders indicating a lower participation in new orders. However, we expect the
execution levels to maintain the current momentum.
In our view, an improving business cycle should bode well for the capital goods sector.
Though stable government at centre post elections is likely to boost the capital cycle,
firm oil prices and continued liquidity crunch may pose risk in near to medium term.
METALS AND MINING
The demand and supply of metals and mining are directly linked to the health of economies.
A growing economy requires them to stimulate industrial, construction and agriculture
sectors. However, metals and mining, being global commodities, the performance of an
individual economy (unless it is China which is believed to be the largest consumer and
producer of metals and mining) will hardly have an impact as it is the performance of
global economies especially economies producing and consuming them the most which
will drive demand and supply of these metals. In the latest World Economic Outlook, the
IMF said that India would grow at 7.3% in FY19E and 7.4% in FY20E. At the global level, the
growth will be at FY17 level of 3.7%. China is forecasted to grow at 6.2% in FY19E.
16 KARVY INVESTMENT STRATEGY REPORT 2019India produces 95 minerals - 4 fuel-related minerals, 10 metallic minerals, 23 non-metallic
minerals, 3 atomic minerals and 55 minor minerals (including building and other minerals).
The government of India has taken initiatives as provided below to give a big push to
metals and mining sector;
yy Under the Mines and Minerals (Development and Regulation) Act of 1957, FDI upto
100% under automatic route is allowed for the mining and exploration of metal and
non- metal ores including diamond, gold, silver and precious ores, while FDI upto 100%
under government route is allowed for mining and mineral separation of titanium
bearing minerals and its ores.
yy FDI caps in the mining and exploration of metal and non-metal ores have been
increased to 100 per cent under the automatic route.
yy The Government of India aims at raising its steel production capacity to 300 million
tonnes (MT) by 2030-31.
Infrastructure projects across all sectors ranging from road, airports, shipping, power,
logistics and telecom continue to provide lucrative business opportunities for steel. Steel
consumption for housing construction is also likely to rise due to the “Housing For All”
initiative which aims to build around 12 million units in urban areas over next three years
and 10 million units in rural areas by 2019. Rise in infrastructural activities will give rise
for demand of minerals like, coking coal, iron ore, manganese ore, zinc, aluminium, etc.
Aluminium production is forecasted to grow to 3.33 million metric tonnes by FY20.
Domestic automobiles sales increased at 7.01% CAGR between FY13-18 with 24.97 million
vehicles sold in FY18. The passenger vehicle sales in India crossed 3.2 million units in FY18
and is further expected increase to 10 million units by FY20. The country’s key strengths
such as a large domestic consumption base, a cost competitive value chain (that includes
low design, testing and validation costs, frugal engineering capabilities and low labor
costs) and strategic geographical location shall help in developing the country as a world
class automotive manufacturing base. Also, higher manufacturing of auto grade steel
shall help in import substitution, pushing demand for domestic steel.
The rise in production of electric vehicles (EVs) could lead to significant changes for
the mining industry, as demand for minerals such as lithium, cobalt, manganese ore
and nickel, used in the production of EVs rises. According to Statista, global demand
for lithium stands at 252,653 tonnes of lithium carbonate equivalent in 2018, but this will
increase to 422,614 tonnes by 2025, as the metal is a key component in batteries that
power electric vehicles.
There is significant scope for new mining capacities in iron ore, bauxite and coal as there
are considerable opportunities for future discoveries of sub- surface deposits.
On the supply side, elevated prices, lower imports (mainly in the US and Europe) and
increased supply from China may prove to be troublesome to metals and mining sector.
In the current scenario, where steel demand is slowing down in China and exports to the
US are restricted, Chinese exports may seek to re-enter a growing Indian market directly
or indirectly. Uncertainty about the impact of lingering US and China trade tensions, rising
interest rates, and the relative strength of the US dollar will influence future prices. India
has real fear of turning into a dumping ground for imported steel from South Korea and
Japan with whom it has Free Trade Agreement as a consequence of the US imposition of
25% duty. The government of India on its part, having introduced Minimum Import Price,
priority in domestic steel procurement and other such measures are expected to protect
the interest of domestic manufacturers.
17 KARVY INVESTMENT STRATEGY REPORT 2019IT SECTOR
Growth momentum to continue
During 2018, BSE IT index returned 25% versus 2% returned by Nifty. We believe that this
outperformance was driven by a) favourable USDINR movement – a fall of nearly 10% YTD
(Rs. 63.7 to Rs. 70 and INR touched an all-time low of Rs. 74.4) b) announcement of large
deal wins by big IT companies c) revival of BFSI in the US and positive commentary on
client spending d) better valuation on a relative basis and e) many large institutions were
underweight in the sector at the beginning of the year. However, we believe that in 2019,
IT index may not outperform broader index on such a magnitude. We believe that at best
it can mimic the performance by broader indices.
In 2018, IT companies’ growth was driven by a combination of USDINR and in case of
some companies like HCLT and TCS, due to ramping up of large deals announced in
the past. In 2019, we believe USDINR will remain stable. We don’t expect INR to make
fresh lows as was the case during 2018. Hence, we don’t expect USDINR to contribute
in a big way to IT companies’ growth. However, in 2019 growth is going to be driven by
ramping up of large deals announced during H1 FY19. TCS announced large deals worth
$5 billion between Jan 2018 and September 2018. HCLT announced 5 large deals. Wipro
announced its largest ever deal worth $1.5 bn with Alight HR Services India. Commentary
from Infy and TechM was encouraging.
However, we believe that IT services companies would find it hard to get hold of the
talent they require, specifically in the areas of new technologies like Artificial Intelligence
(AI) and Machine Learning (ML). Accenture in its Q1FY19 concall has highlighted that it
is becoming difficult to find the right talent in these new age technologies. Similarly,
Infosys indicated that it is looking to invest for a partial stake or buyout firms with the
right talent pool in the areas of newer technologies as it is finding it hard to recruit talent
with capabilities in the new technologies like AI and ML.
18 KARVY INVESTMENT STRATEGY REPORT 2019INDIAN ECONOMIC
OUTLOOK
The sharp rise in oil prices which had raised concerns about widening trade deficit and
the need for preemptive rate hikes due to INR depreciation has quite settled for now.
However, the stress still remains on the fiscal front owing to the upcoming elections.
Also, sluggish export growth signals a caution to the current account position.
During Q2FY19, the Indian economy grew at 7.1% vs. the consensus estimate of 7.4%.
During Q1FY19, GDP grew at 8.2% YoY. This indicates growth is on track to roughly meet
the RBI estimate of 7.4% growth for the entire fiscal year considering that November saw
activity in manufacturing and services sector pick up. The Gross Fixed Capital Formation
(GFCF) increased by 12.5% YoY during Q2FY19 as compared to 6.1% during Q2FY18.
We expect capex spending to lead growth on the back of higher capacity utilisation
which recorded 73.8% in Q1FY19 vs. 71.2% in Q1FY18. Bank credit growth accelerated
in September 2018 where private sector banks recorded more than 20% growth. The
credit-deposit (C-D) ratio at the all-India level improved to 76.4% in September 2018
as compared to 75.6% in the previous quarter. Therefore, we expect this GDP growth
momentum to keep pace on the back of higher personal consumption indicated by
increasing bank credit. Risks to the outlook are largely on account of external sector, the
lagged impact of currency depreciation and uncertain political outlook.
Exhibit: GDP Growth YoY (%)
15
12
9
6
3
0
Dec-…
Sep-00
Sep-18
Sep-06
Sep-09
Sep-12
Sep-03
Jun-10
Jun-98
Dec-08
Dec-17
Jun-01
Dec-02
Jun-04
Jun-16
Jun-13
Mar-99
Jun-07
Mar-11
Sep-15
Mar-14
Dec-99
Dec-11
Dec-14
Mar-05
Mar-08
Mar-17
Mar-02
Source: Bloomberg, Karvy Research
Exhibit: Capacity utilisation (%)
76% 74%
73%
74%
73%
72%
72%
71.9%
74.0%
72.0%
74.6%
75.2%
70%
73.8%
72.9%
71.0%
74.1%
71.8%
71.2%
71.2%
72%
68% 71%
Q2FY16
Q2FY18
Q3FY16
Q3FY18
Q2FY17
Q3FY17
Q4FY16
Q4FY18
Q4FY17
Q1FY19
Q1FY18
Q1FY17
Capacity Utilization 4-quarter average
Source: RBI, Karvy Research
19 KARVY INVESTMENT STRATEGY REPORT 2019Exhibit: IIP and 3M Moving Avg
10
8
6
4
2
0
Jun-16
Jun-18
Jun-17
Feb-16
Feb-18
Feb-17
Oct-16
Oct-18
Oct-17
Dec-14
Aug-14
Dec-15
Dec-16
Aug-15
Aug-16
Aug-18
Dec-17
Aug-17
Apr-15
Apr-16
Jun-15
Apr-18
Apr-17
Feb-15
Oct-14
Oct-15
-2
IIP (%) 3M Moving Avg IIP (%)
Source: MOSPI, Karvy Research
With escalating US-China trade tensions, the World Trade Organization (WTO) expects
global trade growth to slowdown which is likely to dampen oil prices yet be maintained
due to the intervention of the OPEC. If oil prices remain at bay, Indian economy will
certainly benefit as the subsidy burden could be minimized.
With New RBI Governor comes a new mandate: After Mr. Urjit Patel resigned citing
personal reasons, Mr. Shaktikanta Das has been appointed as the 25th RBI Governor.
While the rest of the Monetary Policy Committee remains unchanged, change in
leadership means a change in stance to “neutral” from “calibrated tightening” cannot
be ruled out. Also the RBI is likely to focus on liquidity and resolving PSU bank issues.
We believe this indicates that the RBI may keep repo rates unchanged for a couple of
quarters. While outlook for inflation has softened (RBI projects 3.8-4.2% in H1FY2019-20,
but with an upward bias), with crude oil prices declining to USD 61 per barrel and food
deflating. However, a reversal in food deflation is a risk to inflation outlook, given that
core inflation is at ~5.7%; thus, the probability of cut in policy rate is low.
The lower inflation projection largely reflects low food inflation as well as lower oil prices.
However, we believe that the inflation risks are still on the horizon, core inflation (CPI
inflation after stripping out food and energy) remains sticky at 6.2% in October 2018.
Inflationary risks cannot be neglected when capacity utilisation is rising, coming in at
76.1% for Q2FY2018-19, PMI for November was 54 a 11-month high. Robust growth and a
closing output gap further increases inflationary risks.
Exhibit: CPI and Core CPI
10.0
7.5
5.0
2.5
0.0
May-14
May-15
May-16
May-17
May-18
Jul-14
Jul-15
Jul-16
Jul-17
Jul-18
Mar-14
Mar-15
Mar-16
Mar-17
Mar-18
Sep-14
Nov-14
Sep-15
Nov-15
Sep-16
Nov-16
Sep-17
Nov-17
Sep-18
Nov-18
Jan-14
Jan-15
Jan-16
Jan-17
Jan-18
CPI (%) Core CPI (%)
Source: MOSPI, Karvy Research
20 KARVY INVESTMENT STRATEGY REPORT 2019RBI to continue to inject liquidity through OMO Purchases: The total injection of durable
liquidity for the month of December 2018 will be Rs. 500 bn. Going forward, RBI has
decided to conduct purchase of Government Securities under Open Market Operations
(OMOs) for an aggregate amount of Rs. 500 bn in the month of January 2019. The
operations will be conducted through five auctions of Rs. 100 bn each.
The exact calibration of the quantum of OMO would depend on sustained changes in
the behavior of currency in circulation, the magnitude of sterilization operations for RBI’s
forex operations and other relevant factors.
Credit growth of SCBs improved by 13% YoY in September 2018 driven primarily by
private sector banks which grew at 22.5% YoY. The asset quality of banks improved as
the GNPA ratio of SCBs (Scheduled Commercial Banks) decreased from 11.5% in March
2018 to 10.8% in September 2018. Going forward, the RBI expects this to continue and
estimates GNPA ratio of SCBs to further decline to 10.3% in March 2019. The stressed
advances ratio is gradually converging to the GNPA ratio following the withdrawal of
various restructuring schemes. Therefore, increasing credit growth coupled with
declining provision ratio is expected to lead to higher economic growth.
21 KARVY INVESTMENT STRATEGY REPORT 2019THE GLOBAL ECONOMIC
OUTLOOK
Near inversion of the US yield curve as well as a sharp 19% decline from all time high for
the S&P 500 has heightened fears of a recession These fears are not restricted to the US
alone, data indicates that Chinese growth may be slowing down significantly and Japan
& Europe (especially Germany) are also showing signs of fatigue.
Exhibit: US yield curve (10 year yield - 2 year yield)
4.0
3.0 19 bps
2.0
1.0
0.0
-1.0
-2.0
-3.0
1976
2010
1978
2000
1986
1988
1996
1998
2014
1982
1992
2004
2016
2018
2006
2008
2012
2002
1980
1990
1984
1994
Source: Bloomberg, Karvy Research
According to the NBER, the longest business cycle expansion in the US lasted for 120
months starting from March 1991 to March 2001. The current cycle, the second longest
expansion in history began in June 2009 and questions about how long the business
cycle expansion will last are natural.
Exhibit: US post World War II Economic Cycle
Peak Trough Peak month Trough month Duration, peak Duration, Duration, peak to Duration, trough
month month number number to trough trough to peak peak to trough
Feb-45 Oct-45 1742 1750 8 80 93 88
Nov-48 Oct-49 1787 1798 11 37 45 48
Jul-53 May-54 1843 1853 10 45 56 55
Aug-57 Apr-58 1892 1900 8 39 49 47
Apr-60 Feb-61 1924 1934 10 24 32 34
Dec-69 Nov-70 2040 2051 11 106 116 117
Nov-73 Mar-75 2087 2103 16 36 47 52
Jan-80 Jul-80 2161 2167 6 58 74 64
Jul-81 Nov-82 2179 2195 16 12 18 28
Jul-90 Mar-91 2287 2295 8 92 108 100
Mar-01 Nov-01 2415 2423 8 120 128 128
Dec-07 Jun-09 2496 2514 18 73 81 91
1945-2009 (11 cycles) 11 58 69 70
Source: NBER, Karvy Research
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