The re-emergence of uncertainty in Europe during the second half of the month, an increase of $3-7/barrel in WTI and Brent crude prices during the month and poor monsoons till date led to high volatility in Indian markets.
Growth in advanced economies continues to be under pressure. US economic growth is slowing with growth in Q2 coming at 1.5% down from 2% in Q1 of 2012. British economy contracted by 2.8% in Q2 of 2012 and 1.3% in Q1 of 2012 while Eurozone was flat in Q1 after contracting by 1.2% in the earlier quarter. Growth in emerging and developing economies has also slowed with China growing at 7.6% in Q2, 2012 down from 8.1% in Q1 of 2012 and growth moderating significantly in India, Brazil and South Africa.
Wholesale price inflation (WPI) for June 2012 was 7.25%, driven by high food and fuel inflation. Consumer price inflation is running high at 10.02% in June 2012. The divergence in WPI and CPI suggests that the moderation in non-food manufactured product prices has not yet been transmitted. Deficient monsoons are expected to impact agricultural production adversely and will result in higher food inflation. Fuel inflation has the potential of remaining high. Factoring these RBI, in its first quarter review, has increased its estimates for WPI for FY13 from 6.5% to 7%.
Since Jan 2012, RBI has taken various steps to ease money supply and promote growth. These include reduction in policy rates by 50 bps in April 2012, reduction in CRR by 125bps since Jan 2012, increase export credit refinance limit from 15% of export credit of banks to 50% in June 2012, reduction in statutory liquidity ratio (SLR) of commercial banks from 24% to 23% on 31st July 2012 coupled with liquidity injection of Rs 860 billion by way of open market operations. This has resulted in reduction in net borrowings under the Liquidity Adjustment Facility (LAF) from 2.2% of NDTL in Q4 of FY12 to 1.3% in Q1 of FY13 and further to 0.7% in July 12.
Domestic growth has, however, decelerated over the last four quarters from 9.2% in Q4 of FY11 to 5.3% in Q4 of FY12 primarily because of significant deceleration in industrial production which has grown only by 0.6% in the first 5 months of CY12 over corresponding period in CY11. This has been caused by significant weakness in investment with fixed capital formation declining from a growth of 14.7% in Q1 FY12 to 5% in Q2 FY12, to -0.3% in Q3 FY12 before recovering to 3.6% in Q4 of FY12. Growth in private consumption is also slowing while the expected positive impact of rupee depreciation on exports is taking longer than expected in a weak global environment.
Factoring in weak monsoon, poor IIP growth, weakness in capital investments and private consumption, RBI, in its first quarter review, has reduced GDP growth estimates for FY 13 to 6.5% from 7.3% earlier. However, various economists expect FY13 GDP growth to be in 5.0-6.0% range
In the Q1 FY13, companies operating in cement, healthcare, FMCG sectors and private sector banks have been delivering results better than expected while companies operating in IT, oil, metal sectors and public sector banks are delivering results weaker than expected. Excluding oil and metals, companies have reported 20-25% YoY growth in earnings in comparison to 8-10% YoY growth in earnings for all companies.
Easing of liquidity is expected to help in reducing yields on short end while yields on10 year paper is expected to remain around current levels. Further, expected reduction in current account pressures, recovery in economic growth and reasonable valuations are laying the foundation for strong returns over the next 2-3 years.