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budget2016

 

Reams of paper have probably been dedicated to the Union Budget already, but here is a detailed analysis after going through the fine print in terms of Budget 2016 and its impact on your personal finances.

Your Income

  1. House Rent Allowance change: This has been hitherto a lesser used deduction as it comes with multiple conditions. Section 80GG allows individuals to claim a deduction in respect of house rent paid. The limit has gone up from Rs 24,000 previously to Rs 60,000 subject to following conditions:

a.If the person is either self-employed or salaried but does not receive deduction for       HRA from the employer

b.Does not own a residential property in the city in which he is staying on rent.

c.If the tax payer owns property at any place other than the one mentioned above, he        should not be claiming benefit of the property as self occupied. That property should be deemed to be let out.

To claim this deduction the tax payer has to furnish a declaration in Form 10 BA

The deduction allowed under section 80GG for payment of rent shall be least of the following:

  1. 5,000 per month
  2. Rent paid less 10% of the total income
  3. 25% of the total income of the tax payer for the year.

Your Expenses

  1. Tax collection at Source introduced – TCS of 1% on purchase of luxury cars of value greater than Rs. 10 lakhs and purchase of goods and services in cash exceeding Rs. 2 lakhs is now being levied. This does not change the price of the product but will create a trail of transactions in cash of high values, targeting cash usage.
  2. Increase in service tax – Service tax has been increased by 0.5% on all taxable services, with effect from 1 June 2016. As a result, expect the costs of all services to go up.
  3. Infrastructure cess- 1% on small petrol, LPG, CNG cars, 2.5% on diesel cars and 4% on high engine capacity vehicles and SUVs, will mean that cars will become more expensive.
  4. Excise duty on branded ready made garments – garments with a retail price of Rs. 1000 and above has changed from Nil to 2% without input tax credit. Thus, expect garments to become a wee bit more expensive.
  5. Excise duty on tobacco hiked – expect cigarettes to be more expensive as a result.

Your Investments

  1. Long Term Capital Gains tax on equities and debt investments did not see any change – This is positive for investors, as there were fears around tax being introduced on equities or the holding period for equities being changed. Status quo is good news.
  2. New Pension Scheme (NPS) – There are 3 types of withdrawals currently allowed under the NPS.
  3. Normal Superannuation – Lump sum withdrawal on retirement, which was 60% earlier has been changed to 40% now. Earlier this withdrawal was taxable. Now the government has proposed withdrawal upto 40% to be tax free. The balance 60% can be used  for purchasing annuities, to make the annuity portion tax free as well. Thus, the NPS is far more attractive as an instrument to be used for your retirement goals now, especially as its ability to permit equity exposure enables you to get the wealth creation benefit of equities over the long term.
  4. Upon death- The entire 100% would be paid to the nominee/ legal heir and there won’t be any purchase of annuity. These entire 100% proceeds are tax free.
  5. Exit before normal superannuation( 60 years) – At least 80% of the acculturated pension wealth of the subscriber should be utilized for purchase of an annuity and remaining 20% can be withdrawn as lump sum. Considering that this is a long term retirement product, be sure to use the NPS to fund your retirement goals, as early withdrawals make it less flexible.
  6. Other pension products like EPF and superannuation – There has been an attempt to bring all pension products on the same page in terms of taxation. Therefore, EPF and superannuation will also permit 40% of the corpus withdrawn to be tax free. The interest earned on the balance 60% of the contributions made post April 1, 2016 will be subject to tax unless it is used to purchase an annuity.

There is also proposed a monetary limit for contribution of employers to a recognized Provident and superannuation fund of Rs. 1.50 Lakh per annum or 12% of employer contribution, whichever is less, beyond which the same will be taxable in the hand of the employee. You could see smaller contributions towards the EPF from employers going forward as a result, and voluntary Provident Fund contributions could also reduce as a result.

  1. REITS (Real Estate Investment Trusts) and InvITs ( Infrastructure Investment Trust) – Real Estate Investment trusts are listed entities that primarily invest in leased office and real assets allowing developers to raise funds by selling completed buildings to investors and listing them as a trust. Previously REITs did not take off due to taxation challenges. This budget has done away with Dividend Distribution Tax, thus enabling exposure to commercial real estate at lower values.

Expect Infrastructure Investment Trusts to also take off as a result of this change in dividend distribution tax provisions.

  1. Gold Bonds- Long term capital gains from the sale of gold bonds will continue to be taxable but now eligible for indexation benefits. This facilitates taking exposure to gold in a paper form.

The budget has also proposed to make interest and capital gains from the gold monetization scheme tax free. Thus yields from gold are possibly now more attractive than rental yields from residential real estate, considering that the returns are tax free.

  1. Measures for deepening of corporate Bond Market-

a. LICof india will setup a dedicated fund to provide credit enhancement to infrastructure projects. The fund will help in raising credit rating of bonds floated by infrastructure companies.

b.Development of an online auction platform for development of private placement market in corporate bonds.

c.A complete information repository for corporate bonds covering both primary and     secondary market segments will be developed jointly by SEBI and RBI.

d.A framework for an electronic platform for Repo market in corporate bonds will be    developed by RBI.

This will enable investors to invest in corporate bonds and give them another option to add fixed income exposure to their portfolio.

  1. Fiscal target to be maintained at 3.5% – With the government sticking to its target of 3.5% of GDP for FY 17, fiscal discipline has been adhered to for now. This could lead to drop in bond yields and could be particularly positive for duration funds or portfolios having longer duration bonds. Transmission of falling interest rates could finally be a reality.

Your Taxes

  1. There has been no major change in income tax slabs , for individuals earning upto Rs 1 crore.
  2. Surcharge- There has been an increase in Surcharge on income above Rs. 1 Crore from 12% to 15%.

For an individual below 60 years with an income above 1 Crore ( eg. 1.1 Crore), he will end up paying approximately Rs 91,000 more due to the 3% increase in Surcharge.

  1. Rebate- Under Section 87A, for individuals with income not exceeding Rs. 5 lakhs, the rebate has increased from Rs. 2,000 earlier to Rs. 5,000.
  1. Dividend Distribution Tax- The amendment in dividend distribution tax law is applicable to dividend declared under Section 115O. The section is applicable to domestic companies and it is proposed to amend the Income-tax Act so as to provide that any income by way of dividend in excess of Rs. 10 lakh declared by such domestic company shall be chargeable to tax at the rate of 10%.The above amendment will have no impact on the dividends received by the Mutual Fund unit holders as dividend paid by a mutual fund scheme to a unit holder is covered under Section 115R of the The Income tax Act, 1961. This will hit investors drawing higher dividends but since it is not applicable to dividends from mutual funds it’s a relief.
  2. Presumptive Tax – This scheme is available for small and medium enterprises with turnover not exceeding 1 crore rupees. These were free from getting audited and maintaining detailed books of account and could pay tax at 8% .This turnover limit has increased to Rs. 2 Crore.

Also under the presumptive taxation for professionals with gross receipts up to Rs. 50          Lakh, the presumption of profits has been introduced to 50% of gross receipts.

This should result in significant time saving and costs for professionals and small business owners. However, remember to read the fine print on this clause.

  1. Reduction in tax slabs for companies with business income upto Rs 5 crores – The path to reduction of corporate tax rates has begun with a 1% reduction in tax rates for smaller businesses. Expect more to follow going forward.
  2. Undisclosed income – A window from 01 June 2016 to 30 Sep 2016 has been introduced for people to pay 45% on their undisclosed domestic income. This undisclosed income will not be subject to any scrutiny if done within this window. This is an attempt to garner additional revenues and solve the challenges of black money.

Your Loans

  1. Additional deduction of Rs. 50,000- For first time home buyers an additional deduction of Rs.50,000 on top of already existing Rs. 2 lakh has been proposed for loans upto Rs. 35 lakh sanctioned during the next financial year subject to the value of property not exceeding Rs. 50 lakh.

All in all, it’s a budget that will probably not change your money life significantly – but it has a little here and a little there. “Fortunately, there is a sane equilibrium in the character of nations. As there is in that of men.”

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With literally thousands of stocksbonds and mutual funds to choose from, picking the right investments can confuse even the most seasoned investor. However, starting to build a portfolio with which mutual fund or stock to buy might be the wrong approach. Instead, you should start by deciding what mix of assets in your portfolio you want to hold – this is referred to as your asset allocation. You should consider an asset allocation strategy based on your

  • Time horizon: Asset allocation will depend on how long can you hold on to that particular asset and whether you need it for a particular goal. If you need any of your assets for let’s say a down payment for your house which is due next year, then probably holding debt/fixed income oriented instruments is an option you should consider. Examples of debt include Bank or Corporate Fixed Deposits, short term bond funds, short term bonds and ultra short term or liquid Funds. On the other hand if you have a long term goal like retirement, you can allocate a large portion to equity oriented instruments and lesser towards fixed income oriented instruments. As you move closer to the goal, you can keep reducing the equity portion while increasing the debt component.
  • Risk tolerance: This is different for each one of us. An individual should have a realistic understanding of his or her ability and willingness to stomach large swings in the value of his or her investments. Risk tolerance will depend on age of an individual – middle aged individuals generally tend to be more risk tolerant, as they may have more capital available for investing and have longer term goals.

 

In a volatile market scenario like the one we are witnessing now, and have also witnessed in the past, asset allocation becomes all the more important. The table below shows Sensex High and low on various dates. It also shows percentage fall from high. As you can see , the 1 year returns are as high as 105.9% from April 2003, but are also accompanied by a negative 1 year return to the tune of -31% from January 2008 during the US subprime crisis. Thus, had someone invested all of their money in equity prior to 2008 without a proper asset allocation in place, he would have incurred high losses in 2008. If someone would have invested keeping their goals, time to goals, risk tolerance, savings and expense pattern in mind, they could have held on to their existing investments while strategically rebalancing their portfolio as against panic selling and booking losses. The situation that we are facing now in 2015 around the Greece bankruptcy crisis and Chinese slow down have also resulted in Indian markets correcting significantly. The fall might look attractive to a lot of investors, and they might start buying irrespective of the asset allocation they might have charted for themselves. In our opinion, such events will come and go, and it will always be a challenge for investors to know how much further they could fall. Therefore instead of trying to time the market or haphazardly investing in what looks attractive,e one should go by ones pre defined asset allocation, because what looks attractive today may lose its sheen tomorrow.

Table 1 : SENSEX fall history

UntitledSource: Bloomberg, Reliance Mutual Fund

Historically, broad asset classes move in relation to each other are fairly consistently (for eg., when stocks are up, bonds tend to be down and vice versa). In diversifying the allocation across asset classes, you can potentially create a portfolio with investments that do not all move in the same direction when the market changes. However, if you only spread investments only by industry (eg. automobiles vs. pharmaceuticals), they are all in the same asset class (i.e., all in equities) and respond similarly to market changes. You are therefore open to much greater market risk. Asset allocation helps keep volatility in check.

Ultimately, there is no one standardized solution for allocating your assets. Individual investors require individual solutions. Asset allocation is not a one-time event , it’s a life-long process of progression and fine-tuning. Empirical data shows that it pays to be diversified across asset classes.

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In recent months, there has been a sense of euphoria about India and Indian financial markets. The current highs that the Indian equity market is witnessing, is on one hand creating elation and on the other hand causing regret, making many investors feel that they lost the opportunity.

Many investors may believe that those who are invested in the equity markets, turned out to be ‘better’ investors. One year ago, investors who did not invest in equities were looked upon as better investors.  So how can one truly be a better investor? I would like to say that all of us can strive to be better at investing by following a few simple steps:

  1. Save and Invest:

All of us do understand that we need to invest but very few of us understand that we can invest only if we first save. Know how much you earn and spend to arrive at what you can save.

  1. Understand where you are investing your money:

Today investors have a plethora of options to choose from – Equities, Fixed income, Commodities, Gold, International Funds, Real Estate. Each of these asset classes comes with associated risks and benefits. Know these details when you are investing. Understand the risks you are signing up for and resultant return expectations.

  1. Understand why you are investing your money

Many a time when we make the investment we do have the reason or goal in mind. But over time, especially when markets go down, we forget these goals. We forget that we were investing for a goal which was many years away, and therefore there is no reason to panic.

  1. Systematize your investing

Being busy individuals, handling paperwork, cheques, banking errands are the last thing on our minds. Hence the need to systematize. By this I mean, automate investments to selected avenues on monthly, quarterly yearly basis by using technology, available systematic investment plans (SIPs), triggers, alerts, ECS and such facilities available today.

  1. Consistency pays

As we all know from the current scenario, emotions do interfere with investing, sometimes they work for us and sometimes against. As we usually decide with our hearts and not our heads, create a discipline to invest a certain amount every month and systematize it.  There are many examples of SIPs in diversified equity mutual fund schemes generating sizeable corpuses, where investors have consistently run SIPs.

  1. Discipline is key

Discipline yourself to refrain from wavering from an agreed asset allocation and investment strategy. It is easy to get swayed, just because someone else invested and made a short term profit and his investment option seems superior. Look at your agreed investment strategy periodically. Portfolio churn is not necessary value adding to your portfolio.

  1. Take professional help

As is the case where we need dieticians, doctors, lawyers, etc. sometimes we need professional help to nudge us into an investing habit. Hire a SEBI Registered Investment Advisor to help you with your financial life.

  1. Monitor and Review

After the effort of making a investment strategy and implementing it, comes the time to check whether the plan is working for you. Review if you were able to stick to the savings plan and investments plan. Were you able to maintain consistency? Review whether improvements are possible to the savings plan. Control what you can control i.e. items such as saving and investing. Review your investment products every six months to see how they are performing against an appropriate benchmark.

  1. Correct and Act

Make corrections if you have swayed away from agreed savings/investments plan, asset mix and exit underperforming investments, even at a loss. Here is where a professional nudge would help. A professional could provide that much needed nudge as she is not emotionally connected with your investments.

  1. Repeat the Loop

Repeat this loop consistently and religiously to better your investing experience.

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For cricket enthusiasts, the last week saw two glorious innings and sixes galore at the World Cup from Chris Gayle and A B De Villiers. Indophiles were seeking the same from the first real budget of the Modi Jaitley duo – some big sixes out of the stadium or big bang reforms as it was more popularly known in the run up to the Budget.

So did Budget 2015 deliver on those expectations?
We thought there were a few sixes, but mostly a combination of singles, twos and boundaries, essentially an innings that is being built for the long term so that India is well prepared to hit many more sixes when it really matters.

  1. Inflation targeting agreement with RBI – Inflation and inflationary expectations have been a huge challenge for India, and we will now have both the Central Bank and the government willing to work together through a Monetary Policy committee to have coordinated action on the inflation front. Inflation is the single largest variable that influences your personal financial plan, so stability around inflation should be your biggest benefit as an investor.
  2. Roll out of the Goods and Services Tax (GST) by April 2016 – We finally have a clear date to look forward to, for a tax regime that is potentially much easier. Remember though, that GST will take a couple of years to settle down, and is not likely to change things overnight.
  3. Scrapping of the Direct Tax Code (DTC) – Stability of a tax regime is most critical and the DTC was trying to change too many things at once. It got a quiet burial in this budget.
  4. Focus on ease of doing business – Whether you run your own businesses or are salaried, the need to get rid of red tape and make it simpler and easier to move forward, will be of huge help. Plug and Play could be significant.
  5. Collaborative Centre State Relationships – The Big Daddy approach of the Central government, getting replaced by a collaborative approach and greater flexibility for states to spend their monies in areas where they think it is most relevant, is refreshing. After all, don’t we all think that it is critical to know what’s happening on the ground to finally decide.
  6. Focus on financial assets – With most Indian households having a significant portion of their wealth in physical assets like real estate and gold, there has been a significant effort to get savings towards financial assets. This focus is evident through the fact that even where the underlying asset could still be physical, products like Real Estate Investment Trusts ( REITs) and sovereign gold bonds get a fillip.

Union Budget 2015 and your financial life

Your income

  1. Additional 2% surcharge on annual taxable income – In case you earn more than Rs. 1 crore, you will need to pay a higher tax due to this enhanced surcharge.
  2. Transport allowance exemption doubled to Rs 19200 per annum – Most people will benefit, and expect your employer to restructure your salary so that this benefit is available for you.
  3. Additional tax saving of Rs 50000 per annum by investing in the New Pension Scheme (NPS) – Whilst the tax break is important, weigh this tax benefit vis a vis the fact that the returns from the NPS are taxable, and necessarily need to be annuitized to a significant extent. Ensure that your choice of a retirement product is not driven by the tax benefit alone.
  4. Higher deductions on health insurance – Limits raised to Rs. 25000 per annum for those below 60 and Rs. 30000 per annum for those above 60. In case of those over 80, even though they may not be covered by health insurance, medical expenses of upto Rs. 30000 will be permitted as a deduction.

Your expenses

  1. Increase in service tax – You will need to pay higher service tax for the services that you consume, as service tax has been raised to 14%. In addition, there is an enabling provision to charge 2% additionally as a cess, which may or may not be used. If introduced, service tax could then move to 16%.
  2. Better targeted subsidies – In the past, we may have all benefited due to the fact that subsidies were provided across the board. With significant focused on direct benefit transfers, expect these subsidies to be available only to those who truly need it. The JAM trinity (Jan Dhan, Aadhaar and Mobile numbers) could have this working quicker than anticipated.
  3. PAN mandatory for all expenses above Rs. 1 lakh – Whilst this will help in curbing unaccounted money, let’s hope that the process does not increase notices to people who are paying all their taxes anyways.

Your Overall portfolio

  1. Scrapping of wealth tax – making it easier for you to decide on which asset class to invest in rather than worrying about tax arbitrage on one asset class over another.
  2. Asset allocation continues to hold the key – Whilst Union Budgets can tactically create some short term opportunities, this budget was devoid of any such big opportunities, and is a more workman like budget , getting you to focus on how your investments are structured to benefit from the long term story of India.
  3. Your overseas holdings need to be fully reported and taxes paid – If you have ever worked overseas or have any monies, bank accounts, assets held overseas and have been too busy to declare them, please ensure you do so now as the penalties are very significant from now on.

Your investments in equity markets

  1. Capital gains tax benefits remain as is – India has one of the most advantageous tax regimes for long term capital gains taxes in equity markets through stocks and mutual funds. There has been no change in this regard.
  2. Corporate tax reduction from 30% to 25% over four years – With the effective tax rate in India being approximately 23% currently, this is unlikely to be a significant change. In fact, for FY 15-16, corporate  taxes will go up marginally.
  3. Multiple answers for foreign investors – Many unanswered questions for foreigners have been answered – no retrospective taxation, GAAR being deferred, a composite cap for foreign investments instead of FPI and FDI limits separately, amongst others.
  4. Infrastructure gets a big boost – The multiplier that infrastructure growth can create, can be significant if the challenges of the past can be addressed. Initiatives like plug and play, greater focus on roads and power, and some innovative financing tools like the National Investment and Infrastructure Fund, could move GDP up significantly, which could see India remain a favorite investment destination for foreigners to invest in through equity markets.
  5. High strategic disinvestment target – Whilst the companies that will be divested is unclear, there is an expectation that privatization could come back as details of this become clearer, ensuring the government stays in businesses only where it absolutely needs to.

As earnings continue to be sluggish, look to build your exposure to equities gradually over the six months to 1 year through systematic investment strategies, so that you can take advantage of volatility driven by news from overseas and domestic issues.

Your investments in fixed income

  1. Fiscal deficit at 3.9% of GDP– With the government sticking to its medium term target of 3% but moving it by a year, it seemed like a tight balancing act, trying to keep the foreigners and rating agencies controlled on one side, and people screaming for growth through higher spending quiet on the other.
  2. Net Market borrowing at Rs 4.56 lakh crores – There was a wide range of expectations on this number, and the fact that it has gone up only marginally vis a vis last year, will mean that supply of government paper will be controlled, thereby helping in controlling interest rates.
  3. TDS on recurring deposits and cooperative banks introduced – As a part of the widening of the tax net, recurring deposits will also be subject to TDS from June 2015 and deposits with cooperative banks will also be subject to TDS.
  4. Dividend distribution tax on debt funds hiked marginally – increased from 28.325% to 28.84 % is unlikely to have any significant impact.
  5. Tax free bonds make a comeback – With the focus on infrastructure, the government has announced issuance of tax free bonds, which should enable investors seeking to lock into interest rates for a longer duration, an option to do so.

Whilst the timing of the next interest rate cut is going to be challenging to guess, the expectation of lower interest rates in the economy over the next 12 -24 months should continue. Thus, having between one third to half of your portfolio to take advantage of falling interest rates through government securities, income funds and dynamic bond funds would be a suggested approach.

Your investments in gold

  1. Import duty on gold remains as is– There was a consensus view that import duties on gold would be reduced either partially or fully. They have been kept as is, keeping domestic gold prices elevated vis a vis international prices
  2. Introduction of sovereign gold bonds – Whilst gold ETFs and gold mutual funds already exist giving you access to the change in prices of gold without holding it physically, gold bonds are expected to also pay a fixed return, making gold a potential income generating instrument from only being dependent on capital gains for investors to generate returns. Details are awaited.
  3. Demonetisation of physical gold – With a significant amount of gold in India lying in cupboards and lockers, the gold monetization scheme that was announced is expected to get investors to deposit their gold and earn a rate of return on it. Similar schemes have not worked in the past, so we will have to see how it is structured to make it succeed this time.

Your investments in Real Estate

  1. Real Estate Investment Trusts ( REITs) and Infrastructure Investment Trust (InviTs) get tax clarity –  Whilst these are very popular overseas, the lack of tax clarity prevented them from taking off. With the pass through status of these vehicles getting clarity, expect these to be launched this year, and a potential new addition to your portfolio.
  2. Black money reduction – Multiple steps like making it mandatory for all payments and receipts for real estate transactions above Rs. 20000 to be in cheque and a benami transaction prohibition bill should result in reduction of black money reduction in real estate.

So whilst India continues on its journey to retain its World Cup Cricket title, let’s hope the implementation of this budget makes India retain its most favoured investment destination status in the years ahead.

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The year 2014 was mostly a year full of positive events for Indian financial markets which caused the equity markets (BSE Sensex) gaining close to 30% in 2014 . Some of the major events that took place are as follows and our outlook in 2015:

  1. Historical electoral results – A strong, pro- growth oriented and business friendly government looks good for economic growth and for businesses. This promise has to translate into big reforms on the ground as most of the early work has been focused on getting the bureaucracy and decisions that were deferred forward.
  2. The GDP growth for Q3 2014 expanded to 5.3% from 5.7% in Q2. It is expected to pick up further to 6-6.5% YOY in FY16 with growth over other parts of the world remaining subdued and hence the gap of India GDP Growth with Global GDP growth is expected to widen as seen from the data below:

1

Source:  IMF, credit Suisse Research, Dec 2014

  1. Current Account Deficit (CAD) widened in 2Q FY15 due to widening of trade deficit. However, it is expected to be in a comfort zone in FY16 with falling crude oil prices offsetting high import growth of non-oil and gold.

2

Source:  RBI, Citi Research, Dec’14

  1. Fiscal Deficit for the first 8 months of FY15 (Apr-Nov) came in at 99% of the budget estimate of 4.1% for the full fiscal year. Whilst it is still possible that the government could achieve the target by controlling spending for this year, the fiscal deficit target of 3.6% of GDP in FY16 could be difficult to meet.

3

Source:  Budget Documents, Citi Research, Nov’14, BE=Budgeted Estimate

  1. Earnings Growth: The private sector in India remains in a deleveraging cycle, saddled with excess debt. However, Corporate Earnings should be better than estimates as corporate margins are significantly below the long term averages and should improve gradually as capacity utilization and business conditions improve in the next 2-3 years which is when the full impact of lower interest costs and softer commodity prices will show up in corporate profits.

4

Source: Motilal Oswal Research, November 2014

The outlook for equities in 2015 could be challenging, but things look promising from a longer term perspective and there is merit in increasing allocation to equities in a phased manner and staying invested. However, every investor should look at their own specific asset allocations rather than specific asset class performances.

  1. Inflation declined to a series low due to lower commodity prices, slowdown in consumer demand, low growth in MSPs and falling oil prices. CPI inflation eased to a series-low 4.4% in November 2014 from 5.5% in October 2014 in year-on-year (y-o-y) terms. This primarily reflected a sharp decline in food inflation to 3.6% in November 2014 from 5.7% in October 2014, as well as a fall in core-CPI to 5.5% from 5.9%. In fact, WPI inflation declined to 0% in November 2014.

5

Source: CSO, ICRA Research

In the December Policy review, RBI kept the rates unchanged and revised the CPI target to 6% for March 2015 and also as per RBI, the risks to the Jan 2016 CPI target of 6% looks balanced. There could be concerns during the first quarter of 2015 as RBI waits for certainty with regards to lower/stable inflation, and fiscal adjustments during the budget before commencing any monetary easing and interest rate cuts. Global concerns over interest rate hike in US and movement of global crude oil prices will also keep investors guessing on the direction of interest rates in India.

Fall in inflation and slow economic growth would lead to cut in interest rates in future. As seen from the chart below, bond yields have moved sooner than policy rates more often. Currently also, the yields have fallen in anticipation of a rate cut.

6

Source: RBI, Bloomberg

RBI is also targeting a real positive return on interest rates to potentially move savings from physical assets to financial assets. This could mean that a 6% CPI inflation would synchronize with a 7% repo rate – which means a 100 bps cut in repo rate over the next 18 months.

Investors will need to have a sufficiently long time horizon ( 12-24  months) when investing in duration strategies now, especially given that the first 25 bps of the expected cuts are perhaps already in the price.

Thus, we would recommend continuing to stay invested in a portfolio with a mix of longer maturities and accrual funds, which are likely to benefit as interest rates are expected come down in the next 18-24 months.

  1. The global equity markets also continue to perform well with US markets reaching new highs. Crude oil prices corrected to a 5.5 year low due to significant new supply of shale gas from U.S., slowdown in global demand, and a reduction in per unit consumption in automobiles due to better and efficient technology. So, there’s enough reason to believe that oil prices will remain favourably low. Obviously, a sharp drop in oil prices can potentially create some pressures in oil exporting countries like Russia and in market players who were perhaps overextended in trading.

Also, lower oil prices reduce inflationary pressures and current account deficits allowing emerging market central banks greater freedom to stimulate domestic economies.

We think 2015 is going to be a year of divergence in economic growth and central bank policy. While the US is leading developed markets growth, Europe and Japan are struggling for growth at this point of time and China is still in search of its sustainable growth formula. So we could have central banks across the globe moving in a de-synchronized manner where US is looking to normalize its interest rate structure, while Japan and Europe will still continue to adopt loose monetary policy conditions to fight deflation in their economy. This divergence in policy action will increase market volatility and require investors to pay more attention to risk management.

  1. Currency: Dollar strength and one of the drivers of this trend is the shale gas revolution which US is experiencing and its impact on shrinking the US economy’s current account deficit. This could pose some challenges for emerging markets but stronger fundamentals should limit the financial risks for those emerging market which have already gone through a course correction over the last 18 to 24 months.

Hence, we continue to reiterate to build a well diversified portfolio with having exposure of between 10-15% into international investments to hedge against currency risk.

  1. Gold prices could continue to remain under pressure in the short term due to the fear of interest rate hike in US. Whilst the INR currently looks a little overvalued and is expected to depreciate, Gold as an asset class could gain value as it has an inverse relationship with the Indian currency traditionally.

Hence, we continue to believe to have gold as small part of the portfolio for the purpose of diversification and hedge currency risk.

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