Inflation ????

The benchmark indices, Sensex and Nifty, fell 18% and 17% respectively during the month of June 2008. Among sectoral indices, the BSE Realty performed unfavorably with a negative return of 35% during the month.

Equity MarketContinuously The month of June witnessed the highest inflation in India, since 13 years, at 11.4%. Crude oil prices continued to rule at about $140 per barrel mark. A few of the large banks in the US continued to write down their portfolios with more warnings of further write offs. FIIs sold shares worth nearly Rs. 110 bn on a net basis during the month.

In the back-drop of these developments, the markets fell by 17% during the month. The near normal monsoons till date, in-line corporate results and the better-than-expected IIP numbers for the month of April 08, failed to stem the downside.

Crude prices have risen by 12% in June 08 (17% rise in previous month) and are higher by 39% in the current calendar year. The prices have more than doubled as compared to May 2007. Crude prices have remained at elevated levels despite initiatives by Saudi Arabia and USA to curb the same. Saudi Arabia has announced that it will be increasing daily output to 9.7mn barrels v/s 9mn currently.

During the month, the Government finally took the decision of raising retail fuel prices and increased prices of petrol, diesel and LPG by Rs.5, Rs.3 and Rs.50 respectively. Prices were raised primarily to reduce the burden on the Oil Marketing Companies who were helpless at the rising crude prices globally.

The corporate profit growth has been the main pillar that has been supporting valuations for Indian stocks. In FY09, there are multiple headwinds for the corporates in the form of a slowing economy, high raw material and fuel prices (crude and other commodities) as well as higher interest rates.

The IIP (Index of Industrial production) for April 2008 grew by 7%, as compared to 11.3% in the same month last year. This was as compared to a 3% growth in March 08 and provided some relief to the markets.

Consensus figures indicate FY09 Sensex estimates at Rs. 990. The implied growth of about 14% over this period and a PEG ratio of less than 1x look reasonable at the current point of time (excluding the embedded value, valuations will be more attractive).

Sectors like IT, Pharmaceuticals, Hotels and Mining are preferred among other sectors.


Debt Markets

Headline WPI inflation for the week ended 21st June 2008 came at a 13-year high of 11.63%. The situation with respect to Headline WPI inflation continues to look grim as we expect the double digit inflation to continue throughout this calendar year.

On June 24, RBI raised the Repo rate with immediate effect by 50 bps to stand at 8.50%, while the CRR has been increased in two steps of 25 bps each from the fortnights of 5th July and 19th July 2008 to ultimately stand at 8.75% after the second round of adjustment.

We expect another 50 bps increase in the Repo rate going forward with a realistic chance of the first 25 bps on the next policy date on July 29. CRR may also be increased dependant on liquidity flows, with the objective of keeping the system at the upper end of the interest rate corridor in the near term.

Bond market is likely to stay bearish for a long time with the heightened uncertainty of more RBI action in the near future. 10-year bond yield closed up at around 9.10% on 4th July with the cut-off yield on the 14-year bond that was auctioned on 4th July coming in at 10.03%. We see the possibility of the 10-year benchmark yield to move higher in the days to come as inflation trends further worsen. The broad indicative range for the rest of this FY trade could be at around 8.50-9.25%. With the uncertainties of monetary policy having increased, the outlook for the bond market may undergo some revisions later.


Forex Markets

The case for a weakening of the Rupee remains a base case scenario at this stage given muted capital inflows and a rising Trade Deficit owing to exceptionally high oil prices. We do not expect the flows to improve substantially this year though one can expect to see some modest improvement in the second half of FY09. The Dollar for Oil Bond swap that is currently being conducted will however help to provide some support to the Rupee and cap the depreciation pressure. Only a significant drop in the international crude oil prices or a sudden unexpected increase in foreign fund flows into India can help reverse the current negative sentiments on the Rupee.

We expect the Rupee to be in a broad range of Rs. 42-43.50 per $ in FY09 although the Rupee can test Rs 44-44.10 per $ in case of any further sharp increase in crude oil prices, heightened political instability and in the event of a massive reversal of flows.


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