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Market Outlook December 2016

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Page 1: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Market Outlook

December 2016

Page 2: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Events that rattled the global and domestic economy

Donald Trump won US 2016 election against its Democrat opponent Hillary Clinton

Modi Led NDA government decided to demonetize high-denomination notes (500 and 1000 rupee notes)

Government decided on a broad tax rate structure to be implemented under GST

Source: SBIMF Research

Page 3: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Events prior to demonetization to curb black money in India

Source: Google news, SBIMF Research

The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015: to deal with undisclosed income stashed abroad.

Direct Benefit Transfers: curbs leakages in government machinery

Foreign Account Tax Compliance Act (FATCA) with US, Renegotiation of Tax Treaties (with tax havens) and Information exchange with several other countries: to combat tax evasion

Benami Transactions (Amendment) Act, 2016: Prohibits benami transactions and provides for confiscating benami properties

‘Project Insight’ by Income-Tax Department : information-driven approach for improving tax compliance

Tax Collection at Source (at 1%) on Cash Sales exceeding Rs.2,00,000/- : to curb high value cash transactions and create an audit trail

Supreme Court monitored Special Investigation Team (SIT) on Black Money

20% Penalty on Real Estate Transactions undertaken in Cash exceeding Rs.20,000/ and other Real Estate Regulations

PAN card must for cash transactions over Rs 50,000 from January, 2015

Only 1% of India’s population pay income tax, according to Income Tax department data.

Income Declaration Scheme, 2016: amnesty window to declare undisclosed income, with penalty payment of 45%

Focus on GST implementation: enables tracing of tax evasion

JAM Trinity: to enable financial inclusion and promote digitalization of financial services

Auction based process to allocate natural resources: checks on inefficiency and bribe-taking mechanism in government

Page 4: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Why demonetization?

Source: RBI, SBIMF Research

‘Demonetization’: withdrawal of legal tender status of 500 and 1000 rupee notes in India w.e.f. 8th November (midnight), barring a few emergency transactions

To address fake high-value

currency notes

Curb illegal and terrorist activities

Curb the Black money in India

• Public have been allowed to deposit/exchange their present holding of these notes in banks/post offices till December 31st, after proper identification

• New 500 and 2000 rupee notes are being issued to substitute the old ones.

• Limits have been imposed on withdrawal of currency notes from ATMs and Banks as RBI has four mints operating in the country and the pace of withdrawal cannot match the pace of deposits

One way of reducing corruption and tax avoidance is to go cashless!

Page 5: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Why did ‘demonetization’ shake India?

86% of Indian currency loses legal status overnight*

0.6 0.8 1.1 1.5 1.9 2.5 3.2 4.0 5.0 6.0 7.5 8.6 9.7 10.8 12.2 14.2 15.2

2.2 2.5 2.8 3.3 3.7 4.3 5.0 5.9 6.9 8.0

9.5 10.7

11.8 13.0

14.5 16.6

17.8

0.0

5.0

10.0

15.0

20.0

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

2006

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

2012

-13

2013

-14

2014

-15

2015

-16

2016

-17

(Oct

)

500 and 1000 rupee notes (in Rs. Trillion)Smaller denomination notes& coins (in Rs. Trillion)Total Currency in Circulation (in Rs. Trillion)

Source: Livemint, Indiaspend, RBI, SBIMF Research; NB: *Oct 2016 figures of 500 &1000 notes are SBIMF’s estimate

12.42

9.47

7.91

4.18 4 3.92 3.36

0

2

4

6

8

10

12

14

India China Germany US Brazil Korea UK

Cash to GDP Ratio (as of 2014)

India depends heavily on cash for economic transactions

• There is one bank branch per 10,000 Indians while there is one ATM per 5,000 Indians. There are 132,834 bank

branches in India, of which 38% (50,554) are rural.

• India has about 700 million debit and 25 million credit cards.

• Agriculture, informal sector workers—about 482 million people - earn cash incomes (~40% of India’s population).

• Rural economy which comprise 800 million people, or 65% of India’s population depend largely on cash.

• The informal economy—presently employs more than 80% of India’s workforce.

• About 950 million people (78% of the population), do not have an internet connection. 30% of India’s population are

smart phone users.

Page 6: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Consequences of Demonetization

Source: SBIMF Research

Unintended Positive Consequences

• Distribution of Wealth effect • Rapid Transmission of rate cuts

may boost credit demand • Multiplier effects of bank deposits • Gold and Real Estate inventory

clearance • Productivity enhancement from

digitalization • Financialization of savings • Catalysis to Digitalization, cashless

economy

Possible Fall Out of Demonetization

• Growth Slowdown – Activity and Wealth effect

• Constrained Consumption • Policy Uncertainty • Derailment of Private Capital

Expenditure • Adverse effect on Real Estate

prices • Fiscal Impact due to slowdown • Balance sheet issues

Page 7: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Impact on Growth: Negative in the near-term

Source: SBIMF Research

• Demonetization has disrupted the business activity significantly, specifically for sectors which thrives on cash as a medium of exchange. Affects the ability to pay wages and make purchase orders for sectors.

• Financial services , on the other hand, will see positive impacts due to influx of low-cost deposits. Expectation of fiscal stimulus will also provide a boost to demand in related sectors.

• Net short-term effect is likely to be negative and to that extent, it can dilute the impact of consumption boost that market anticipated from the rolling out of 7thPay commission and improvement in rural income due to better harvest.

• To gauge the lasting impact of demonetization one needs to distinguish between liquidity, wealth, and income effect. Loss of demand due to liquidity effect would be transient and can be recouped to a large extent. The wealth effect impacts select sectors. However, consumption lost because of underlying incomes taking a hit may not necessarily be recouped.

• In the long run, both GST implementation and curbing of black money are structurally positive for growth.

4.9

5.6

7.1 7.2 7.2

5.1

6.0

7.2 7.6

7.2

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

FY13 FY14 FY15 FY16 FY17 (till 1H)

GVA at basic prices Real GDP

Liquidity Impact: Can be recouped to a large extent once currency

flow normalizes

Wealth effect: Can adversely impact select sectors. In long run, distributional wealth effect may

lead to neutral impact on growth

Income effect: Consumption lost because of underlying incomes

taking a hit may not necessarily be recouped. Can have adverse spiral

effects and may take longer to correct

Growth impacts

Selective

Page 8: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

CPI inflation: Impact mildly deflationary

Source: CSO, SBIMF Research

• Latest Inflation print (4.2% in October) depicted considerable softening in prices primarily due to fall in vegetable and fuel prices. However, certain food prices has worsened in the last month and pose concern. Inflation ex-food and fuel remain considerably sticky.

• Demonetization is likely to cause temporary fall in inflation due to reduced cash availability and hence reduced spending. This may lower the prices of discretionary goods and services (16% weight in CPI basket) and prices perishable food items. However, the effects may be transitory and a large portion of CPI basket may remain unaffected from demonetization (with apprx 45% food, 10% fuel and light and 10% housing rentals.

CPI Inflation softened considerably to 4.2% in October …as food and fuel prices fell

-4.0-2.00.02.04.06.08.0

10.012.0

Jan-

14

Mar

-14

May

-14

Jul-1

4

Sep-

14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-1

5

Sep-

15

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-1

6

Core CPI (CPI ex food ex fuel) CPI Food

CPI: Transport and communication

% y-o-y

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

Jan-

12

Apr-

12

Jul-1

2

Oct

-12

Jan-

13

Apr-

13

Jul-1

3

Oct

-13

Jan-

14

Apr-

14

Jul-1

4

Oct

-14

Jan-

15

Apr-

15

Jul-1

5

Oct

-15

Jan-

16

Apr-

16

Jul-1

6

CPI % y-o-y

CPI target range 4% + 2%

Page 9: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Fiscal health of the economy will get a positive boost

Source: Budget documents, SBIMF Research

7.1 7.3 7.1 7.4 7.2 7.2 6.5 7.0 7.0

8.8 9.5 9.9 10.1 9.7 9.4 10.8 10.6 10.2

15.2 16.0 16.2 16.8 16.1 15.9 16.3 17.1 17.1

02468

101214161820

2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 BE 2015-16 RE 2016-17 BE

Centre State Total

Tax Collection (as % of GDP)

Both GST implementation and curbing the black money will boost the tax buoyancy for the government in the long-run

• Fiscal health of the economy will definitely see an improvement due to both these measures of GST implementation and

curbing the black money, though it may be marginally negative in the short-term due to implementation cost and reduced business activity. States tax collection which may also be adversely impacted due to reduced real-estate activity.

• In the long-run, demonetization, along with other measures such as GST implementation, DBT, Real estate regulations , PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading taxes (and hence black money size in India)

• We are likely to see a massive improvement in revenue collection, whether it be through better tax to GDP ratio, through penalty payments (for black money) or through profit transfer from RBI (a likely possibility from this currency demonetization).

Page 10: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Equity Market Outlook

Page 11: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Source: Bloomberg, SBIMF Research,

Fall in Indian Equity

NIFTY fell 370 points in last one month due to twin effects of EM sell-off post Trump’s victory and demonetization

Page 12: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Global equity market snapshot: November 2016

Performance in November 2016 (local currency returns)

Source: Bloomberg, SBIMF Research

• Nifty (-4.7%) under performed most of the global markets during the month. However it delivered inline performance with MSCI EM index.

• Brazil/Russia/Pakistan/Indonesia happen to the best performing markets globally YTD. Sri Lanka/China/Japan amongst the laggards.

• India underperforms the MSCI Emerging markets index in YTD terms.

Performance YTD (local currency returns)

-8

-5 -5 -5 -4 -3 -3 -2 -1 -1 -1 -1

1

3 4 5 5 5

7

(10)(8)(6)(4)(2)02468

PHIL

IPPI

NES

INDO

NES

IAN

IFTY

MSC

I EM

BRAZ

IL UK

SRI L

ANKA

KORE

AM

SCI E

M -

EURO

PEHA

NG

SEN

GTA

IWAN

GERM

ANY

FRAN

CES&

P 50

0RU

SSIA

CHIN

AJA

PAN

DOW

JON

ESPA

KIST

AN

-9 -8 -4 -2 -1 -1

1 4 4 8 9 9 10 11 12 12

30 36

43

(20)

(10)

0

10

20

30

40

50

SRI L

ANKA

CHIN

AJA

PAN

PHIL

IPPI

NES

FRAN

CEGE

RMAN

YKO

REA

NIF

TYHA

NG

SEN

GS&

P 50

0M

SCI E

M UK

DOW

JON

ESTA

IWAN

MSC

I EM

- EU

ROPE

INDO

NES

IAPA

KIST

ANRU

SSIA

BRAZ

IL

Page 13: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Indian stock market snapshot: November 2016

Performance in November 2016

Source: Bloomberg, SBIMF Research

• Nifty/Sensex was down 5% in Nov’16. On YTD basis, the NIFTY index is up by 4%.

• Metals emerged as the top performers for the month, as well on a YTD basis.

• Real estate and Auto have been the worst hit sector during the month.

• Mid-caps (-7.2%) and Small-caps (-9.2%) under performed during the month, but outperformed on a YTD basis.

• Year-to-date, IT services and healthcare have been the worst performing sectors.

Performance YTD

-17

-9 -8 -7

-6 -6 -5 -5 -5 -5 -5 -4 -3

-1 0

4

(20)

(15)

(10)

(5)

0

5

REAL

EST

ATE

AUTO

SMAL

L CA

P

MID

CAP

CAP

GOO

DS

BSE

500

FMCG

BSE

100

NIF

TY

BAN

KEX

SEN

SEX

PHAR

MA

OIL

& G

AS IT

PSU

MET

ALS

-11 -7 -5

-1

2 3 4 4 5 5 9 10 12

16

25

44

(20)

(10)

0

10

20

30

40

50

IT

PHAR

MA

REAL

EST

ATE

CAP

GOO

DS

SEN

SEX

FMCG

NIF

TY

SMAL

L CA

P

BSE

100

BSE

500

AUTO

BAN

KEX

MID

CAP PS

U

OIL

& G

AS

MET

ALS

Page 14: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Source: Antique, SBIMF Research,

Earnings may see a downward revision

• Profits for Indian companies have been weak in FY15 and FY16 on the back of weak export and domestic demand, stressed balance sheet, high real interest rates, fall in global commodity prices (affecting the commodity related companies), delayed investment cycle and relative appreciation of rupee vis-à-vis the trading partners.

• The earnings narrative were expected to change since 2H FY17 and there were visible signs of cyclical recovery, beginning with a noticeable slowdown in the pace and magnitude of downgrades. 2Q FY17 posted 6.6% growth in PAT earnings for the NIFTY companies after nearly six consecutive quarters of near-zero growth.

• Markets expected a boost earnings from moderating interest rates, favourable base for select cyclical like metals and PSU banks and boost in consumption related sectors from normal monsoon after two consecutive years of drought and from 7th Pay Commission pay-outs, and very.

• The earnings narrative has now changed significantly post demonetization. Demonetization will significantly dent the expected boost in consumption. Earnings and consequently market performance in the near term will be a function of pace of re-monetization and recovery in sectors thriving on cash spending.

• Needless to say, global factors like global bond yields, capital flows and currency movement will also weigh. Second, the phase of commodity cost tailwinds – which drove margin expansion over FY14-16 – is now behind as commodity costs have bottomed out. This could pose downside risks to margins in an environment of demand compression.

For FY17, earnings were expected to grow by as much as 14%. Both FY17 and FY18 expectations is likely to be revised downward post the demonetization exercise

95 128

175 207

239

283 247

284

330 351

385 427

391 403

460

-20%

-10%

0%

10%

20%

30%

40%

0

50

100

150

200

250

300

350

400

450

500

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

e

Nifty EPS (RS.)% y-o-y (RHS)

Page 15: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Source: Bloomberg, Morgan Stanley, SBIMF Research,

Corrections in Indian Equity Valuations

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

27-Dec-00 27-Dec-03 27-Dec-06 27-Dec-09 27-Dec-12 27-Dec-15

MSCI India's P/E prem. wrt MSCI EM

India’s valuations relative to other EMs have come-off in recent months …

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0% MSCI India ROE Relative to EM

…while the relative RoE continues to strengthen

Page 16: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Liquidity: DII inflow cushioned the market

Source: Antique, NSDL, SBIMF Research

FIIs have sold US$ 3.3 bn from equity market and US$ 4bn from the debt market between Oct-Nov

DIIs, on the other hand, pumped in US$ 3.9bn in last two months

-10000-8000-6000-4000-2000

02000400060008000

May

-13

Aug-

13

Nov

-13

Feb-

14

May

-14

Aug-

14

Nov

-14

Feb-

15

May

-15

Aug-

15

Nov

-15

Feb-

16

May

-16

Aug-

16

Nov

-16

Equity Investment Debt Investment

USD mn

-1.5 -1.2

-0.2

0.2

-2.2

-1.1 -0.8 -0.8 -0.5

0.4

-0.2

0.7

-1.2

0.9

-1.3

0.3 0.0

1.8 1.3

1.9

0.1

2.5

1.6

-0.2

1.3 0.9

1.9 1.5

-2.5

-0.4

1.1

-0.3 -0.9 -0.7

0.3

1.2

2.7

Nov

-13

Feb-

14

May

-14

Aug-

14

Nov

-14

Feb-

15

May

-15

Aug-

15

Nov

-15

Feb-

16

May

-16

Aug-

16

Nov

-16

Page 17: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Market outlook

• The sudden shock of demonetization of high denomination currency in India and victory of Donald Trump in US 2016 election (between 8th and 9th November) caused sharp fall in the Indian equity markets- party due to a broader sell-off from the emerging markets space and partly due to the India-specific reasons.

• Sensex is down 4.6% during the month. Expectedly, performance down the cap curve was far worse with the BSE Midcap index and the BSE Small-cap index underperforming the large cap Sensex by 2.8% and 4.5%, respectively.

• FII flows hit a 12-month low with net selling exceeding USD-2-bn during the month. This was offset by significantly higher buying by domestic institutions, both Insurance and MFs.

• Valuations have corrected and are currently hovering at its long-term average of 16 times forward earnings.

• The demonetization impact might sustain for more than a quarter or two but given that there are too many moving parts, its bit too early to call. While the disruption in economic activity particularly on discretionary consumption may drive sentiments, one must not lose sight of the fact that a good part of index earnings (Technology, healthcare, energy, staples, telecom, global commodities etc.) may remain largely insulated. Barring the risk of a deeper slowdown leading to systemic balance sheet issues, ‘Digitalisation of finance’ and ‘financialisation of savings’ actually augur very well for financials (almost 30% of index).

• It is important to note that government over the last 2-years has taken measures keeping in mind long-term structural gains for the economy even at the cost of short-term pains. We believe that corrections due to these disruptive forces offers opportunity to investors as the developments are positive from a structural long-term perspective.

Valuations are at 16 times on 1 year forward earnings

Source: Bloomberg, SBIMF Research

7.0

9.0

11.0

13.0

15.0

17.0

19.0

21.0

23.0

25.0

Dec/

05Ju

l/06

Feb/

07Se

p/07

Apr/

08N

ov/0

8Ju

n/09

Jan/

10Au

g/10

Mar

/11

Oct

/11

May

/12

Dec/

12Ju

l/13

Feb/

14Se

p/14

Apr/

15N

ov/1

5Ju

n/16

Sensex 1Y fwd PE

Mean: 16

+1 SD

-1 SD

Page 18: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Debt Market Outlook

Page 19: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Global rates snapshot for Nov 2016: Bond yields are fast rising

• There has been a subtle shift in the direction of global bond yields over the last three month with markets doubting the incremental

effectiveness of additional QE/Monetary easing on aggregate demand.

• With the election results in the US, there has been a further rise in treasury yields, increase in long term market implied inflation expectations and curve steepening.

Source: Bloomberg, SBIMF Research

10 Year Gsec Yield (% mth end) 2014 end 2015 end Sep-16 Oct-16 Nov-16

Change m-o-m (in bps)

Change YTD (in bps)

Developed market

US 2.17 2.27 1.59 1.83 2.38 56 11

Germany 0.54 0.63 -0.12 0.16 0.28 11 -35

Italy 1.57 1.35 0.99 1.66 1.99 33 64

Japan 0.33 0.27 -0.09 -0.05 0.03 7 -24

Spain 1.61 1.77 0.88 1.20 1.55 35 -22

Switzerland 0.32 -0.06 -0.55 -0.39 -0.13 27 -7

Page 20: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Barring India, emerging markets bond yields are rising

Source: Bloomberg, SBIMF Research

10 Year Gsec Yield (% mth end) 2014 end 2015 end Aug-16 Sep-16 Oct-16 Nov-16

Change m-o-m (in

bps) % change

in 3m

Change YTD (in

bps)

Emerging Market

Brazil 12.36 16.51 12.08 11.58 11.40 11.83 44 -25 -468

China 3.63 2.83 2.79 2.72 2.74 2.94 20 16 11

India 7.86 7.76 7.11 6.82 6.79 6.25 -55 -86 -151

Indonesia 7.75 8.69 7.09 7.02 7.21 8.09 88 100 -60

Korea 2.63 2.08 1.48 1.42 1.68 2.15 47 67 7

Malaysia 4.12 4.19 3.59 3.55 3.62 4.35 73 75 16

Philippines 3.95 3.95 3.95 3.95 3.95 4.52 58 58 58

Russia 9.39 9.62 8.20 8.15 8.58 8.82 25 -80 -80

South Africa 7.96 9.76 9.05 8.66 8.70 9.02 32 -74 -74

Taiwan 1.61 1.02 0.68 0.68 0.68 1.18 50 16 16

Thailand 2.69 2.49 2.26 2.10 2.13 2.69 56 20 20

Page 21: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

India Rates Snapshot for November 2016

• The withdrawal of the high denomination notes as legal tender led to massive deposits of money at bank branches. Given the ceiling on withdrawal of cash, the liquidity in the banking system rose sharply. At the same time, growth disruptive effects of demonetization led markets to expect deeper rate buts in the economy. Improved liquidity and rate cuts expectations led to softening of yields across the curve.

• Indian bond yields have softened massively with 10-year G-sec touching a low of 6.10% in November end, though the yields moved up post December 9 MPC meet to trade at 6.44% of 9th December. Money-market rates, too, softened on the back of anticipation of improvement in liquidity.

• Crude oil prices fell 9.6% over the month, but rose 25% YTD. Rupee depreciated sharply by 2.4% against the US Dollar in November.

Source: Bloomberg, PPAC, SBIMF Research; NB: **Crude oil price is average $/barrel for the month, rest of the data are % month end; *Corporate bond rate is for AAA rated bonds ,*** Refers to PSU Banks CD rate; # INR and Oil price changes are % change

Sep-16 Oct-16 Nov-16 Change YTD (in

bps) m-o-m change

(in bps) 1 Yr T-Bill 6.55 6.44 6.05 -117 -39 3M T-Bill 6.42 6.37 5.95 -119 -41 10 year GSec 6.82 6.79 6.25 -151 -55 3M CD*** 6.61 6.58 6.15 -105 -43 12M CD*** 7.06 6.93 6.48 -123 -45 3 Yr Corp Bond* 7.55 7.48 7.03 -130 -45 5 Yr Corp Bond* 7.60 7.52 7.16 -123 -36 10 Yr Corp Bond* 7.67 7.65 7.20 -122 -46 1 Yr IRS 6.47 6.35 6.00 -107 -35 5 Yr IRS 6.36 6.35 6.07 -89 -28 Overnight MIBOR Rate 6.50 6.24 6.51 -52 27 INR/USD 66.6 66.8 68.4 3.4# 2.4# Crude Oil Indian Basket** 45.1 49.2 44.5 24.6# -9.6#

Page 22: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

India vs. US interest differentials: narrowed rapidly in last three months

Source: CMIE economic outlook, Bloomberg, SBIMF Research

India US interest rate differential narrowed down rapidly by 130-140 bps in last two months

Page 23: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Strengthening dollar bodes depreciation pressure for EM currencies

Source: Bloomberg, SBIMF Research

Dollar Index has moved above 100 after nearly 13 years

Page 24: Market Outlook December 2016 - SBI Funds Outlook_dec 2016.pdf · PAN card requirement for higher denomination transaction will create a background which reduces the scope of evading

Commodity prices are rising

Source: Bloomberg, SBIMF Research; NB: Data as of 6th December

Commodity prices have moved up YTD posing an upside risk for inflation

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Currency

Source: Bloomberg, SBIMF Research

-9 -11

-2

-19 -17

-2 -2 -4 -6 -12

-1

-15

-6 -1

-30-25-20-15-10

-505

1015

Afric

an R

and

Braz

il Re

al

Chin

ese

renm

inbi

Colo

mbi

an P

eso

Hung

aria

n Fo

rint

Indi

an R

upee

Indo

nesia

n Ru

piah

Kore

an W

on

Mal

aysia

n Ri

ngitt

Mex

ican

Pes

o

Phili

ppin

e Pe

so

Polis

h Zl

oty

Russ

ian

Roub

le

Taiw

anes

e Do

llar

Thai

Bah

t

Turk

ey L

ira

% change in 2014 % change in 2015 % change YTD

Indian rupee has been relatively less volatile and depicted marginal depreciation bias since 2014 at a time when most other Emerging Market currencies depicted large swings on either side

0.02.04.06.08.0

10.012.014.016.018.0

Jan-

01Ja

n-02

Jan-

03Ja

n-04

Jan-

05Ja

n-06

Jan-

07Ja

n-08

Jan-

09Ja

n-10

Jan-

11Ja

n-12

Jan-

13Ja

n-14

Jan-

15Ja

n-16

Avg volatility of EM currency INR volatility

India has built maximum FX reserves in 3 years which can help RBI cushion currency market volatility

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Overall external account is still comfortable

Trade deficit has fallen to US$ 5-8bn per month since 2016 (vs. 10-12bn in 2015)- due to fall in oil and gold import

Source: CMIE, RBI, SBIFM Research

Low trade deficit has helped Current Account deficit to stay below 2% of GDP

India’s Net FDI inflow sufficient to fund Current account deficit since FY15

FX reserves at US$ 367bn as of October end is sufficient to finance 12 months of import

10 10 16

28 38

48

78 88

32 27 22

3 8 16

22 18 12

22 20 22 31 36

0

20

40

60

80

100

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

CAD Net FDI

USD bn

6

8

10

12

14

260280300320340360380

Jan-

10Ap

r-10

Jul-1

0O

ct-1

0Ja

n-11

Apr-

11Ju

l-11

Oct

-11

Jan-

12Ap

r-12

Jul-1

2O

ct-1

2Ja

n-13

Apr-

13Ju

l-13

Oct

-13

Jan-

14Ap

r-14

Jul-1

4O

ct-1

4Ja

n-15

Apr-

15Ju

l-15

Oct

-15

Jan-

16Ap

r-16

Jul-1

6O

ct-1

6

FX reserves (USD bn)- LHS Import cover (in months RHS)

-8.0 -7.0 -6.0 -5.0 -4.0 -3.0 -2.0 -1.0 -

-35.0

-30.0

-25.0

-20.0

-15.0

-10.0

-5.0

-

Mar

-11

Jul-1

1

Nov

-11

Mar

-12

Jul-1

2

Nov

-12

Mar

-13

Jul-1

3

Nov

-13

Mar

-14

Jul-1

4

Nov

-14

Mar

-15

Jul-1

5

Nov

-15

Mar

-16

Current Account Balance (US$ bn) as % of GDP- RHS

0

5

10

15

20

25

30

101520253035404550

Jan-

10

Jun-

10

Nov

-10

Apr-

11

Sep-

11

Feb-

12

Jul-1

2

Dec-

12

May

-13

Oct

-13

Mar

-14

Aug-

14

Jan-

15

Jun-

15

Nov

-15

Apr-

16

Sep-

16

Trade Deficit (USD bn)- RHS Exports (USD bn)

Imports (USD bn)

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Currency outlook

Source: CMIE economic outlook, SBIMF Research

Indian currency has strengthened against its trade partners

• Over the last two months dollar has strengthened and bond

yields across the globe has rallied rapidly.

• India has been an exception to see bond yields falling massively at a time when even emerging markets rallied by anywhere between 50-100bps. This has narrowed down India’s interest differential vis-à-vis similar US treasury papers by at least 100 bps in last three months across the yield curve.

• Thus, Indian rupee, which has been a story high carry and low volatility, will see some loss of attractiveness on the former.

• Nearly US$ 80bn of foreign currency reserves has been amassed by the Indian central bank, at a time, when most other emerging markets dipped into their reserves. This provides some muscle power to the RBI to contain the rupee volatility. I

• While rupee depicted marginal depreciation against dollar, it strengthened against its trading partners in last three years.

• Looking ahead, in the event of depreciation in other emerging market currencies, rising crude prices and strengthening dollar, we do envisage sharper depreciation in rupee next year.

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Banking system Liquidity to see sustained improvement

Source: RBI, SBIMF Research

• Currency Leakage has picked up pace in last two years which has been out-of-sync with the pace of economic growth. High currency leakage, on the margin, leads to tightness in the banking system liquidity.

• Liquidity has gone large shifts in Q3 FY17 to surplus zone. Currency in Circulations plunged by Rs. 7.4 billion, net of replacements up to December 2. Deposits in banking system surged in parallel.

• RBI implemented variety of measures to suck this surplus liquidity. Incremental CRR of 100% was implemented for a fortnight, variable reverse repo window was scaled up, oil bonds issued by government was allowed as eligible securities under LAF and limits on securities under market stabilization scheme (MSS) was scaled up from Rs. 0.2 trillion to Rs. 6 trillion on November 9. Cash Management Bills under MSS has been issued to the tune of Rs. 1.4 trillion by 6th December.

• Some of the cash is likely to permanently stay in the system as bank deposits even after conditions normalizes and hence lead to a permanent improvement in banking system liquidity.

8.0

10.0

12.0

14.0

16.0

18.0

Jan-

12

May

-12

Sep-

12

Jan-

13

May

-13

Sep-

13

Jan-

14

May

-14

Sep-

14

Jan-

15

May

-15

Sep-

15

Jan-

16

May

-16

Sep-

16

Growth in Currency in Circulation (% y-o-y)

Currency leakage from the banking system accelerated in last two years

Return of currency to the banks without a parallel withdrawal led to drastic improvement in liquidity

-4000-3000-2000-1000

0100020003000400050006000

6-Ap

r-15

6-Ju

n-15

6-Au

g-15

6-O

ct-1

5

6-De

c-15

6-Fe

b-16

6-Ap

r-16

6-Ju

n-16

6-Au

g-16

6-O

ct-1

6

6-De

c-16

Banking System Liquidity (Rs. Billion)

+1% of NDTL

-1% of NDTL

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Banks lending rates may fall due to availability of low cost deposits

Loan growth remains soft while deposit growth surged further

Source: CMIE, RBI, SBIFM Research

MCLR has fallen by 25bps in November

• Buoyed by the demonetization drive, the deposit portfolio surge further by Rs. 5.3 trillion in November. Banks’ deposit growth thus increased to 16% y-y, highest in past few years and much higher compared to 1H FY17 growth of 9.5%.

• Some of the cash is likely to permanently stay in the system as bank deposits even after conditions normalizes and hence lead to a permanent cheaper source of funds for banks. Banks have already reduced their deposit rates for varying tenors due to the comfortable liquidity.

• Over the next couple of months, banks' lending rates is likely to come down due to fall in deposit rates and due to competitive pressure created by rate cuts announced by some of the banks.

• Weak near term credit demand can support bonds, until the working capital demand shifts to banking channels from the cash based channel. While we anticipate some of the informal lending demand to come to the formal banking system, a big jump in credit growth will depend on pick up in capital spending cycle.

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

Jan/

13

Apr/

13

Jul/1

3

Oct

/13

Jan/

14

Apr/

14

Jul/1

4

Oct

/14

Jan/

15

Apr/

15

Jul/1

5

Oct

/15

Jan/

16

Apr/

16

Jul/1

6

Oct

/16

Bank Deposit (% y-o-y) Credit % y-o-y-LHS

8.58.68.68.78.78.88.88.98.99.09.0

Apr/16 Jun/16 Aug/16 Oct/16 Dec/16

MCLR (Overnight) in %

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RBI, in its 7th December MPC meeting left the repo rate unchanged contrary to market expectations of 25-50bps of rate cut. In doing so, the central bank had been influenced by multiple considerations, both domestic and external, as well as the lack of adequate data to judge the extent and the persistence of any growth slowdown associated with the decision of cancelling legal tender status of specified bank notes (SBNs).

Over the last two months dollar has strengthened and bond yields across the globe has rallied rapidly. India has been an exception to see bond yields falling massively at a time when even emerging markets rallied by anywhere between 50-100bps. This has narrowed down India’s interest differential vis-à-vis similar US treasury papers by at least 100 bps in last three months across the yield curve. Thus, Indian rupee, which has been a story high carry and low volatility, will see some loss of attractiveness on the former. Consequently, these developments puts incremental pressure on Indian rupee.

While the demand weakness in India and improved agricultural supply lifts off some pressure from inflation, rupee depreciation and rising commodity prices leads to imported inflation in India.

Further, the availability of comfortable liquidity in the banking system is aiding the central bank’s objective of rate cut transmission. Both deposit and lending rates have fallen in November at a pace much faster than seen in entire 2016 thus far.

We expect the central bank to closely monitor the growth impact of the currency cancellation to determine any persistence in the same. At the same time, monetary policy actions are unlikely to be independent of any material financial stability concerns arising from global developments, given that any such events could have feedback loop into domestic macros though the currency channel. Currently, the decision of further rate cuts is more likely to be reactive to data points rather than time dependent.

Rate Outlook

Source: RBI, CSO, SBIFM Research

4.00

5.00

6.00

7.00

8.00

9.00

10.00

Jun-

05

Mar

-06

Dec-

06

Sep-

07

Jun-

08

Mar

-09

Dec-

09

Sep-

10

Jun-

11

Mar

-12

Dec-

12

Sep-

13

Jun-

14

Mar

-15

Dec-

15

Sep-

16

Repo Rate (mth end, %)

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There has been a shift in the direction of global bond yields over the last month with markets doubting the incremental effectiveness of additional QE/Monetary easing measures on aggregate demand.

With the election results in the US, there has been a further rise in treasury yields across the developed markets, increase in long term market implied inflation expectations and curve steepening.

Within the emerging markets too, barring India, yields have risen in all the key markets in last three months.

Exuberance driven by easier near term liquidity and hopes of policy easing have led to domestic yields getting disconnected entirely from global trends as well as markets under-pricing near term risks arising from weakness in currency as well as some uptick in commodity prices. Consequently, the central bank’s decision to leave the repo rate unchanged contrary to market expectations of 25-50bps of rate cut led to an immediate negative reaction from the market, with yields moving up by about 20-30bps.

The recent demonetisation of high value notes can have major medium-long term positive structural effects such as: a) potential additional government tax revenues from better compliance over the coming years, b) increase in tax/GDP ratios seen in conjunction with GST and c) reducing the role of cash economy and additional access to formal financial sector.

While fiscal situation can improve significantly over medium term, the market can also take comfort from near term weakness in headline CPI.

In this environment, the trend for a medium term easing in market yields remains intact driven by incremental news flow on potential benefits to government revenues over the medium term.

In the very short term, global yield volatility , shifting expectations of US Fed stance and lack of OMO’s /higher net supply will keep the markets volatile with slightly upward bias.

Market Outlook

Source: RBI, Bloomberg, SBIFM Research

6.00

6.50

7.00

7.50

8.00

8.50

9.00

9.50

Jan-

11M

ay-1

1Se

p-11

Jan-

12M

ay-1

2Se

p-12

Jan-

13M

ay-1

3Se

p-13

Jan-

14M

ay-1

4Se

p-14

Jan-

15M

ay-1

5Se

p-15

Jan-

16M

ay-1

6Se

p-16

10 year GSec yield (mth end, %) Repo Rate (mth end, %)

Average spread between G-sec and Repo in last 10 years: 75bps

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Thank you

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Disclaimer

This presentation is for information purposes only and is not an offer to sell or a solicitation to buy any mutual fund units/securities. These views alone are not sufficient and should not be used for the development or implementation of an investment strategy. It should not be construed as investment advice to any party. All opinions and estimates included here constitute our view as of this date and are subject to change without notice. Neither SBI Funds Management Private Limited, nor any person connected with it, accepts any liability arising from the use of this information. The recipient of this material should rely on their investigations and take their own professional advice.

Mutual Funds investments are subject to market risks, read all scheme related documents carefully. Asset Management Company: SBI Funds Management Private Limited (A joint venture with SBI and AMUNDI). Trustee Company: SBI Mutual Fund Trustee Company Private Limited.

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Contact Details

SBI Funds Management Private Limited

(A joint venture between SBI and AMUNDI)

Corporate Office: 9th Floor, Crescenzo, C-38 & 39, G Block, Bandra Kurla Complex, Bandra (East), Mumbai - 400 051 Tel: +91 22 6179 3000 Fax: +91 22 6742 5687/88/89/90/91 Website: www.sbimf.com

Call: 1800 425 5425

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Email: [email protected]

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