2017 INDIA

INVESTMENT
OUTLOOK
January 2017
 2017 INDIA INVESTMENT OUTLOOK

WHAT’S INSIDE

1 | THE YEAR GONE BY

2 | EQUITY MARKETS IN 2016

3 | EQUITY MARKETS – OUR OUTLOOK FOR 2017

4 | FIXED INCOME MARKETS IN 2016

5 | FIXED INCOME MARKETS – OUR OUTLOOK FOR 2017

The Year Gone By

To say that the year 2016 went by without much ado would be a complete misnomer, for there would have hardly been a
dull moment in the past 12 months. From concerns around hard landing of the Chinese economy to Brexit event to a rise in
the negative yield-bearing assets globally to the stupendous demonetization drive in India to the US presidential election
victory of Donald Trump, the year has been action-packed to say the least.

• On the macroeconomic front, while there was a sharp recovery in the global crude oil prices (23%), consumer price
index (CPI) inflation remained benign and twin deficits remained contained. Metals rallied in 2016, bouncing back from
the 2015 lows and on expectation of a revival in Chinese demand. Weak credit growth during the year further
aggravated by demonetization move, posed headwinds for the Banking sector. Discretionary spending showed a
negative growth trend in Nov-Dec period on muted demand on account of the note ban move.

• FPI (Foreign Portfolio Investors) flows into Indian equity markets for CY2016 stood at a 5-year low of USD 2.90bn
(INR 187.82bn). Further, FPIs remained net sellers to the extent of USD 6.5bn (INR 442.97bn) into fixed income
markets during the year. Interestingly, DIIs (Domestic Institutional Investors) ploughed in INR 372bn into Indian
equities during the year surpassing the net flows from FPIs.

• On the equity market front, a slowdown in the Chinese economy, UK’s vote to exit the EU, weakness in global trade
growth, policy normalization by the US Federal Reserve, rise in global commodity prices and the US elections weighed
on the market movements during the year.

• Indian fixed income markets which started the year on a cautious note, had a lot to cheer in 2016 especially post
demonetization. The steep drop in 10-year benchmark yield by around 113 bps during the year stands out amongst
developed and emerging markets.

2017 INDIA INVESTMENT OUTLOOK | 1

Equity Markets in 2016
Equity Indices performance in 2016
Cyclicals outperform defensives DMs and commodity centric EMs gain in 2016
Domestic indices performance 2016 Domestic indices performance 2016
S&P BSE Metal 36.65 Russia RTS 52.22
S&P BSE OIL & GAS 27.17 Brazil Bovespa 38.93
S&P BSE PSU Jakarta Composite 15.32
12.88
FTSE 100 14.43
S&P BSE Auto 9.39
Dow Jones 13.42
S&P BSE MidCap 7.97
Taiwan Taiex 10.98
S&P BSE Bankex 7.35
S&P 500 9.54
Nifty Free Float Midcap 100 7.13 Reuters/Jelferies CRB Index 9.29
S&P BSE 200 3.95 MSCI Emerging Markets 8.58
Nifty 500 3.84 Nasdaq 7.50
S&P BSE 500 3.78 S&P/ASX 200 6.98
S&P BSE Fast Moving Consumer Goods 3.29 Xetra DAX 6.87
Nifty 50 3.01 MSCI AC World Index 5.63
S&P BSE Sensex 1.95 CAC 40 4.86
S&P BSE SmallCap KOSPI 3.32
1.77
MSCI AC ASIA ex JAPAN 2.88
S&P BSE POWER 1.53
MSCI AC Asia Pacific 2.33
S&P BSE Capital Goods -3.28
S&P BSE Sensex 1.95
S&P BSE REALTY -5.98
Nikkei 0.42
S&P BSE Consumer Durables -6.34 Hand Seng 0.39
S&P BSE Information Technology -8.00 Singapore Straits Times -0.68
S&P BSE TECK -9.16 FTSE Eurotop 100 -0.88
S&P BSE Healthcare-12.88 SSE Composite-12.31
Source: Bloomberg

Cumulative FPI flows at 5-yr low; DII flows surpasses Resurgence in global commodities in 2016
Inflows INR Cr Cumulative FII, DII inflows CY2016 BSE Sensex
FPI - INR 187.82 bn 29000
Commodity trends in CY2016
50000
70%
28000 61% 59%
40000
60%
27000
30000
50%
26000
20000
40%
25000
10000
30% 23%
0 24000
DII - INR 372 bn
20% 17%
23000 14%
-10000
9%
10%
-20000 22000
01/Jan
14/Jan
28/Jan
10/Feb
24/Feb

13/Jun
24/Jun
08/Jul
21/Jul
09/Mar
22/Mar

05/May
18/May
31/May

10/Oct
25/Oct
07/Nov
21/Nov
02/Dec
15/Dec
28/Dec
06/Apr
22/Apr

03/Aug
17/Aug
30/Aug
14/Sep
27/Sep

0%
Gold Brent Crude Aluminum Zinc Copper Steel
Cumulative FPI inflows Cumulative Domestic Institutional inflows BSE Sensex (S/Met.ton) (S/lbs)

Source: CDSL, BSE India, Bloomberg

• A slowdown in Chinese economy, UK’s vote to exit the EU, weakness in global trade growth, policy normalization by the
US Federal Reserve, rise in global commodity prices and the US elections weighed on the Indian equity markets during
the year.
• Despite global events impacting risk sentiments during the year, domestic positives supported the market such as normal
monsoons, a rise in the area under cultivation for winter crop (YoY 5.9% by December), moderating inflation and
implementation of 7th pay commission which are expected to boost consumption.
• Commodities rallied in 2016, bouncing back from the 2015 lows and on expectation of a revival in Chinese demand.

2017 INDIA INVESTMENT OUTLOOK | 2

Equity Markets Our outlook for 2017
Major themes to impact Indian markets in 2017 include resurrection in consumption
demand, growth led by policy reforms, move towards digitization, monetary
stance of global central banks and economic policy decisions.

The impact of demonetization may weigh on consumption demand and on the

growth of various industries in the near term, dragging down the GDP growth for
FY17 by 50 bps. The approval of promulgation of the Special Bank Notes (SBNs)
(Cessation of liabilities) ordinance by the President of India could likely bring
about a gain to the government on account of allowance given to the RBI to
extinguish its liability towards unreturned SBNs. We expect the impact of this
currency replacement program to be short lived as new notes come into
circulation (45% back in circulation as on December 17th). Additionally, this
move should help to increase the share of formal economy and digital economy.
Improvement in consumption demand is expected to be a major theme for 2017
supported by a gradually rising rural wage level, implementation of the 7th pay
commission, lowering of interest rates in the Indian economy and continued Anand Radhakrishnan
government spending. Chief Investment Officer
Franklin Equity – India
Fiscal deficit dropped by 52.3% YoY in Nov on pick-up in tax receipts (direct and
indirect) even as non-tax revenue was down. However the achievement of fiscal
deficit target for FY17 would warrant a tradeoff between government spending to
counter the slowdown from demonetization and expectation of a fall in tax
revenue in H2FY17.

Policy reforms led growth – Interest subvention of 3% and 4% for housing loan announced in December 2016 may boost
low cost housing segment. Post the fixation of tax structure by the GST council, GST law now awaits implementation in
2017. This simplification of tax structure along with reforms pertaining to land, labor, infrastructure sectors and modification
in FDI policy could contribute to sustainable growth over medium term.

Global factors including commodity price movements, economic policies of the new government in the US and monetary
policy stance of global central banks could have a bearing on capital flows to emerging markets like India. A likely rise in
inflation pressure in the US from wage rise and expansion in the economy should elicit future interest rate hike actions by
the US Federal Reserve in 2017. Global growth rate is likely to improve, led by the US and other emerging economies in
2017 which could benefit the Indian export oriented sectors. That said, India’s lower linkage to global economies makes
the domestic macro factors and fiscal trends the key catalysts to determine growth.

Improving fiscal situation, inflation rate, exports growth, rising FDI flows point towards fundamental stability in the economy
which augurs well for long term equity investing. Domestic corporate earnings volatility may increase as corporates
attempt to tide over the impact of currency replacement program. Earnings for FY17 are expected to be lower than
estimate with EPS growth likely at around 10%. Consensus earnings growth for FY18 is expected to be healthy at high
teens. The fundamental strength of the economy and attractive valuation levels of the market (1 year forward P/E for BSE
Sensex at 14.7x, moderate levels implying low risk) present a positive outlook for equity. Periods of interim weakness in
equity market should be considered as investment opportunities for long term investors. We recommend a systematic
investment in diversified equity funds & hybrid funds to benefit from the current volatility and participate in the growth
potential of Indian equities.

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Fixed Income Markets in 2016
Rebound in the global crude oil prices CPI inflation remained benign

Fiscal Deficit under control Deposit Growth picks up post CRP*

INR depreciated vis a vis US dollar But, Foreign Exchange Reserves remain robust

Source: Bloomberg, PPAC, CGA, Morgan Stanley (MS) Research estimates, CMIE, RBI, MS Chartbook – December 2016
*CRP stands for Currency Replacement Program

• On the macroeconomic front, while there was a sharp recovery in the global crude oil prices (23%), consumer price
index (CPI) inflation remained benign and twin deficits remained contained.
• The banking system has been flooded with liquidity post the announcement of Currency Replacement Program
(CRP). Subsequently, deposit growth has picked up post CRP.
• The rupee has depreciated close to 3% against the dollar. We believe RBI’s reasonable foreign exchange reserves
may provide some cushion against Rupee depreciation in 2017.

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Fixed Income Markets Our outlook for 2017
Although bond markets started off 2016 on a subdued note, the sharp drop in
10-year benchmark yield by around 113 bps (most of it came after
demonetization) led to softening of bond yields across the curve.
• We believe that slowdown in growth (aftermath of demonetization) and
expected soft inflation could probably leave room for rate cuts by the RBI,
which could augur well for duration strategies in 2017.
• There were credit concerns on individual companies during 2016, however,
improving credit ratio seems to indicate that we broadly appear to be in a
credit upgrade cycle, though it could take time for credit cycle to pick up.
Anticipated fall in the lending rates post the currency swap exercise (increase
in bank deposits) would help to bring down cost of capital for Indian
companies, which in turn may bode well for the improvement of the credit
environment and thus benefit accrual strategies.

The liquidity in the banking system has improved post demonetisation which
would henceforth result in lower deposit and lending rates.
Santosh Kamath
• Given the cash rich nature of our economy, we could see some slowdown in
Chief Investment Officer
the overall economic activity thereby weighing on the GDP growth. Fixed Income - India
• The trade-off between 1) likely positive impact of demonetization in form of
lower interest rates over medium to long term and 2) pick-up in macro-
economic growth, once the consumption gathers momentum, will be
instrumental in shaping up the direction of interest rates in 2017.

CPI inflation which had been muted in 2016, fell to a two year low more recently due to softer food inflation.
• Given the good monsoon season and expected slowdown in consumption post currency replacement program,
we believe that March’17 inflation could undershoot RBI’s target of 5%.
• Conversely, the RBI seems to be concerned about inflationary risks. In its Dec monetary policy review, the RBI
surprised by leaving policy rates unchanged stating that growth pain on account of demonetisation is ‘transitory’ and
that there is enough demand in the system to make it worry over inflation. Going ahead, the RBI will assess durability of
the fall in inflation for implementing further interest rate cuts.

The rupee has depreciated close to 3% against the US dollar, however, it was among the better performing emerging
market currencies in 2016. While higher crude oil prices and expectations of stronger U.S. growth coupled with earlier and
more aggressive interest rate hikes in the US may impact INR, however, contained twin deficits, improving domestic
macroeconomic indicators and RBI’s reasonable foreign exchange reserves may provide some support.

Although India is in a relatively better position among the emerging economies, there are risks which can weigh on the
Indian bond markets.
• Faster than expected raise in interest rates by US Federal Reserve, rising political uncertainty in Europe and OPEC’s
deal on production cut could spike up the oil prices, impacting the global bond markets.

• Meanwhile, at home the actual economic impact of the currency swap program will become clear in 2017 and the date
of implementation of the goods and services tax (GST) could be pushed ahead.

The infusion of fresh deposits in banking system (post demonetization) is likely to shore up demand for G-Secs by banks,
which could eventually augur well for bond prices. We recommend investors (who can withstand volatility) to consider
duration bond/gilt funds for medium to long term horizon. Although, the lack of growth in private sector capex has delayed
the pick-up in credit cycle, our corporate bond funds continue to offer reasonably high portfolio yields providing higher
accrual income opportunities for the short-to-medium term.

2017 INDIA INVESTMENT OUTLOOK | 5

Note: We have relied on third party data which, we believe to be correct but, we do not offer any
assurance as to the accuracy or the correctness of the same and would not accept any liability for any
loss or damage arising directly or indirectly from action taken, or not taken, in reliance on material or
information contained herein. The information contained in the above commentary is not a complete
presentation of every material fact regarding any industry, security or the fund and is neither an offer
for units nor an invitation to invest. This communication is meant for use by the recipient and not for
circulation/reproduction without prior approval. The views expressed by the portfolio managers are
based on current market conditions and information available to them and do not constitute
investment advice. Past performance may or may not be sustained in future.

Mutual Fund investments are subject to market risks, read all scheme related
documents carefully.

Copyright © 2017. Franklin Templeton Investments. All rights reserved.

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