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Today marked the 3rd Bi-Monthly policy statement by the RBI for the FY 2018-19 with members voting 5-1 in favor of a rate hike.

This was largely in line with market expectations and was already priced in, as post the release of the minutes of the monetary policy bond yields did not move much in either direction.

However, the MPC also continued to maintain a neutral stance, indicating that it is trying to play a delicate balance between inflation and growth, and decisions are being taken with the objective of achieving the medium term target for CPI at 4% within the range of +/- 2% and future data prints

The MPC mentioned that domestically various indicators suggest that economic activity has continued to be strong. Significant turn around in the production of capital goods and consumer durables, Progressive monsoon and increase in MSPs of Kharif crops are expected to boost rural demand by rising farmer’s income. Vehicle sales augur well for urban income growth.

Retail inflation i.e. CPI grew to 5% in June from 4.9% in May, driven by an uptick in inflation in fuel. Food inflation remained muted due to lower than usual seasonal uptick in prices of fruits and vegetables in summer months. Adjusting for the estimated impact of the 7th central pay commission’s house rent allowances (HRA), headline inflation increased from 4.5 per cent in May to 4.6 per cent in June. Low inflation continued in cereals, meat, milk, oil, spices and non-alcoholic beverages, and pulses and sugar prices remained in deflation. Factors mentioned above have resulted marginally downward revision in inflation projections for Q2 vis-à-vis the June statement. However, projections for Q3 onwards remain broadly unchanged on account of uptick of 20 bps in inflation expectation for 3 months and 1 year ahead horizon survey of households by RBI’s. RBI’s industrial outlook survey also reported higher input costs and selling prices in Quarter 1 of 2018-19. Input cost of companies polled in services PMI in June also stayed elevated. Farm and non farm input costs rose significantly in June.

The central government has decided to fix the minimum support prices (MSPs) of at least 150 per cent of the cost of production for all kharif crops for the sowing season of 2018-19. This increase in MSPs for kharif crops, which is much larger than the average increase seen in the past few years, will have a direct impact on food inflation and possible secondary impacts on headline inflation. Uncertainty around the full impact of MSP on inflation will only resolve in the next several months once the price support schemes are implemented and procurement by the government is visible.

Based on an assessment of the above-mentioned factors, inflation is projected at 4.6 per cent in Q2, 4.8 per cent in H2 of 2018-19 and 5.0 per cent in Q1:2019-20, with risks evenly balanced. Excluding the HRA impact, CPI inflation is projected at 4.4 per cent in Q2, 4.7-4.8 per cent in H2 and 5.0 per cent in Q1:2019-20.

The MPC notes that domestic economic activity has continued to sustain momentum and the output gap has virtually closed. However, uncertainty around domestic inflation needs to be carefully monitored in the coming months. In addition, recent global developments raise some concerns. Rising trade protectionism poses a grave risk to near-term and long-term global growth prospects by adversely impacting investment, disrupting global supply chains and hampering productivity. Geopolitical tensions and elevated oil prices continue to be the other sources of risk to global growth. On account of these risks, RBI governor stated that by keeping the neutral stance, the Monetary Policy Committee have kept the option of further rate increase or decrease open and dependent on future data.

With an election year upon us and possible fiscal risks emanating, along with global outflows on the back of higher US interest rates and a falling rupee, this may not be the last of the rate hikes in our view.

Your Investments

Financial markets have continued to be volatile and driven mainly by monetary policy stances in advanced and emerging economies and geopolitical tensions. Globally, equity markets have been volatile on trade tensions and uncertainty around Brexit negotiations. However, it also important that public finances do not crowd out private sector investment activity at this crucial juncture.

Capital flows to Emerging Economies declined in anticipation of monetary policy tightening in Advanced Economies. Also currency of Emerging economies have depreciated against the US dollar over the last month on account of strong USD supported by strong economic data.

Equities continue to remain overpriced from a price to earnings perspective in spite of recent corrections and a better growth outlook. However, good results so far by many companies, along with good growth expectations and better capacity utilisation bode well for earnings growth going forward.

Real rates continue to remain positive.The rising G-sec yield makes dynamic bonds and long term bond funds unattractive and the exposure to the same should be minimized. Bonds with a shorter duration of 3 months to 2 years are ideal in the given scenario. We therefore, continue to believe that investors should continue to have fixed income exposure through a combination of lower duration and short term strategies.

Your Loans

With an increase of 25 basis points by the RBI, the deposit rate of the banks could further increase which would be followed by lending rate hikes. Thus we suggest looking at prepaying or raising EMI amounts on your loans to negate the interest rate hike and future hikes that could follow.

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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:

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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.

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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.

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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.

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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.

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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.

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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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Recently one of my good friends received a job offer with an upcoming IT company in Silicon Valley which would take him away from India for at least a few years. I congratulated him on his dream job in a new country and he asked me about what to do with his existing investments and potential NRI investment options in India? This is a question that comes to us very often from NRIs all over the world – whether they are in the Middle East, Europe, Australia or the US.

With the Indian economy being one of the fastest growing economies in the world and a home bias that tends to exist for many families, many NRIs choose to invest in Indian markets to achieve their life goals such as planning for a child’s education and marriage, planning to purchase a property in India or abroad, or planning for one’s retirement.. Whilst both Indian equities and Indian real estate, along with Indian fixed income options are a great way to boost the overall yields on your portfolio, there are a few critical items that you need to keep in mind especially as you try to build a large corpus to sustain life events that you would come across during your 25-30 years post retirement, when there would be no income stream of salary or professional income to depend on.

Choice of Assets & planning for them

You need to have a financial plan in place so you can have a holistic view of your finances to make financial decisions with confidence. Having large accumulated savings in your bank account can sometimes expose you to taking investment decisions that are sub-optimal for your overall financial health, as you may be in a hurry to put it away.  Your financial plan will show you how much you need to invest starting today, for each of your life goals, and will also enable you to create an appropriate mix of equity, fixed income and real estate exposure in your portfolio.

Repatriating your money:

Confused with so many bank accounts? You need to be clear whether you want to invest your funds in Indian rupee or a foreign currency, and also if you wish to have complete flexibility in repatriating the monies overseas. A NRE account that is designated in INR can be a savings account, current account or term deposit account without any taxes from an Indian perspective, and allows complete repatriability. Once you become an NRI, your existing bank account will be converted to an NRO account (Non Resident – Ordinary). You can deposit all your earnings in India into a NRO account. As per RBI guidelines, you can remit or repatriate an amount up to USD 1 million per financial year from the NRO account.

Currency Fluctuations:

When you earn and spend in one currency, and invest in a different currency, currency risks have to be well understood in relation to the goals and investment product selected. An investment today may offer attractive returns in rupee terms; it may not remain attractive when it is repatriated. Considering that India has traditionally being a high inflation economy vis a vis many other global economies, potential currency depreciation tends to be an important factor to keep in mind.

Tax Treatments:

It is critical to understand the tax implications in both countries as a part of your financial plan. You may need to seek the help of a tax advisor in both India and your home country, so that there is complete clarity on the same. In addition, there may be Double Tax Avoidance treaties in place that allow you to set off the taxes you pay at in one country against taxes due in India, or vice versa, so that you are not taxed twice on the same amount. This is extremely critical as income which is tax free in one country may be subject to tax in the other, and it is therefore critical to get good tax advice around the choice of investment products that you buy.

Frequent Home Visits:

This is one type of recurring and large expense many families may be facing overseas. It may be  common for some NRIs, that they should book and send tickets for their parents and other close relatives, when they have to visit them in the host country, or certainly when they visit India. Don’t forget to add this as a different goal in your financial plan.

To conclude, NRIs need to better understand the potential currency fluctuations, taxation and income and expenses pattern in their country of residence and retirement, before making investment decisions. Creating a financial plan should help you and your family have a very clear roadmap for yourself and your family.

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Indian Equity markets once again touched all time highs by crossing the 28500 level on the BSE SENSEX due to various reasons like structural reforms made by strong government, weak commodity and oil prices, inflation easing further, improvement in macros and continued foreign flows on the back of strong  liquidity conditions overseas

Equities:  The CNX Nifty and CNX Midcap increased by approx. 6% in the last one month. The local market sentiment has remained buoyant through the last few quarters as the market anticipates a strong domestic recovery and lower interest rates in an improving policy environment. Various macro factors like GDP growth, Current Account Deficit (CAD), Fiscal deficit (FD), IIP, WPI and CPI are showing an encouraging trend in FY 2014-15, compared to last year FY 2013.

Featured imageSource:  Citi Research, HDFC MF, Colored rows refer to yearly data; other represent quarterly data

Corporate margins are currently at cyclical lows, and though earnings are still to significantly pick up and may take a few more quarters, better managed companies are starting to show some traction. As corporate margins normalize from depressed levels and as interest rates move lower, current P/Es that look expensive could start to look much more justifiable.

However, it is critical to have a long term horizon for investors buying into equities as always, as there could be volatility in the short term, especially with a consensus positive view on India. A consensus positive view tends to be a good contrarian indicator very often, so having a long term view and holding some cash to buy on corrections could be a good idea.

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While the U.S. continues to normalize its monetary policies, the same does not apply elsewhere. To overcome weakness in Europe, China and Japan, the respective central banks are taking steps towards more monetary easing to stimulate growth in their economies.

Emerging Markets like India and China have adopted a more flexible exchange rate system, increased Foreign Exchange reserves and managed their external debt in an efficient way thus far.

Featured imageSource: MSCI, Credit Suisse, I/B/E/S, FactSet, J.P. Morgan Economics, J.P. Morgan Asset Management “Guide to the Markets – Asia.”

Investors should remain disciplined in maintaining a well-diversified portfolio by investing across domestic and international equities. A global economic recovery should favour equities, especially emerging markets like India and China that are likely to benefit from a global recovery.  Both emerging markets and developed markets should benefit as a result.

Over the long term, the INR should continue to depreciate vs. the USD at nearly the rate of inflation differential between India and US (last 30 years CAGR of INR depreciation vs USD is 5.5 %; inflation differential between India and US is 4.8%). Therefore, we continue to recommend building international exposure in the portfolio for the purpose of diversification and act as a hedge against currency risk.

Fixed Income: While the equity market is on a high, there are good investment opportunities that we foresee in the fixed income market. There are various factors that impact inflation and the table below shows that they are moderating:

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Investors should start looking at bonds and bond funds (a combination of short, medium and long term options would be recommended, depending upon investment objectives and risk appetite) as a means of hedging their future reinvestment risks.

Globally the gap between US &Indian interest rates is currently high, yet, a sharper than expected reversal in US interest rates could lead to volatility / challenges for the Indian fixed income markets as well. Foreign portfolio flows into debt have also been at a high for many months now, as can be seen from the graph below, and thus investors need to be cautious about any reversal in fund flows. Thus maintaining a long term view on fixed income investments (18-36 months) wouldalso be crucial.

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CPI inflation eased to a series-low 5.5% in October 2014 from 6.5% in September 2014 in year-on-year (y-o-y) terms.  This primarily reflected a sharp decline in food inflation to 5.8% in October 2014 from 7.6% in September 2014, even as core inflation was unchanged at 5.9%.

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Source: CSLO, ICRA Research

However, RBI may not cut the rates in the upcoming monetary policy in December unless they are very sure of achieving CPI inflation target of 6% by January’2016. In addition, it may want to reward investors with continued positive real returns of between 1%-1.5% p.a. over and above inflation, which should help monies move from physical assets like real estate and gold to fixed income instruments as well.

Gold: Gold may continue to see downward pressure globally, with weak commodity prices, and less fear amongst global investors. The government has removed gold import restrictions in spite of the fact that gold imports went up significantly in the last festive month to $3.75 billion. Hence, allocating only a small portion of your investments into this asset class continues to be a good strategy in our view.

We came across a very interesting table recently showing the returns on CAGR basis and the risk measured by standard deviation over 1, 3 and 5 years holding periods of the BSE SENSEX, 1 year SBI Fixed deposit (FD) and Gold in INR terms for the last 30 years:

Featured imageSource: Bloomberg, HDFC MF

As you can see from the above data that:

FDs vs Gold: Fixed deposit returns are very close to the Gold returns in the last 30 years; however the volatility or risk in gold is much higher compared to the risk in FD. Hence, Gold is not a superior option compared to FDs to invest in from a risk perspective.

Equities vs Gold:  Long term returns on equities are much higher than returns on gold (appreciation in Sensex was 5x of gold*). Volatility of equity returns is high but to a lesser extent (3x over 3 year holding periods and 2x over 5 year holding periods). Equities are therefore a superior asset class compared to gold for long term investments and for those with tolerance to volatility.

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India equity markets celebrated Diwali in style, with the Nifty regaining the 8,000 mark and the Sensex moving above 27000.

There was plenty of positive news flow from India like the Government announcing a series of policy reforms including diesel deregulation, gas price hikes and e-auction of the cancelled coal blocks. The victory of the BJP in the Assembly elections in Maharashtra and Haryana too buoyed sentiments.

Equity:

Nifty increased by 1.02% whereas CNX Midcap increased by 1.44% during the month.

The Price to Equity ratios continues to show that equity market valuations are above 20 Year average and it is therefore critical to see earnings pick up to justify current valuations . Early signs show that it is starting to happen as you can from the chart below on both PAT and EBITDA margins for Nifty companies:

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Source: Motilal Oswal Research, 2014

In the graph below it is very clear that investment growth has picked up recently in India compared to some of the other emerging markets (like Brazil, Russia and Mexico), but needs to rise further for economic growth to improve structurally.

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Source: Morgan Stanley Research, October 2014

Global economic growth woes continued – the IMF downgraded its economic outlook on the globe due to weaker than expected global activity in the first half of 2014, along with ongoing Middle East tensions, the Ukrainian and Russian standoff, along with the Hong kong political unrest. The new epidemic disease Ebola is also a big concern in U.S, African and European countries. News from Europe also continues to be challenging. The US ended its bond buying program but maintained its stances on keeping interest rates low for a considerable period, in line with market expectations. Whilst it is very tempting to move to a 100% domestic portfolio in this environment, we continue to recommend to have at least 10% of the portfolio invested globally for the purpose of global diversification, as well as act as a hedge against currency risk.

With projections of GDP growth of 5.5 percent in FY 2014–15 and 6.5 percent in the following year, Q2 2014 GDP growth came at 5.7%, above the consensus expectations. We believe that the Indian economy is on the cusp of a growth uptrend and this will contribute to growth in corporate earnings as we have shown in our charts above in this article and hence will justify strong performance of Indian equities, especially with oil and commodity prices coming off. However, it is critical to keep you asset allocation intact.

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Source: MSCI, Credit Suisse, I/B/E/S, FactSet, J.P. Morgan Economics, J.P. Morgan Asset Management “Guide to the Markets – Asia.”

Fixed Income

CPI inflation eased to a series-low 6.5% in September 2014 from  7.8% in August 2014 in year-on-year (y-o-y) terms and Core-CPI inflation (excluding food, beverages & tobacco and fuel & light) declined significantly to a series-low of 5.9% in September 2014 from 6.9% in August 2014 (refer chart below)

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Source: CSO, ICRA Research

Inflation related to fuel & light moderated to 3.5% in September 2014 from 4.2% in August 2014 in y-o-y terms. Softening of prices of various commodities including crude oil and domestic fuel prices would benefit the CPI trajectory in the near term and hence we continue to expect the Reserve Bank of India’s (RBI) January 2015 target of restricting CPI inflation below 8.0% to be achieved.

Nevertheless, the probability of a Repo rate cut in 2014-15 remains low, as the RBI is likely to continue to focus on containing inflationary expectations to improve the likelihood of restricting CPI inflation below the January 2016 target of 6.0%.

The below chart shows the Interest rate differentials between US and India:

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Source: Axis Mutual Fund

There is a fear that higher US rates will draw FII money away from India. This is not borne out by history. During 2004-06 even with rate hikes money continued to flow into India from FIIs. Secondly, back in 2004 at the start of the cycle, US rates were at 1% and Indian rates were at 4.5% implying a 350 bps differential. By the end of the Fed rate hikes, the rates were respectively 5.25% and 6.50% implying a differential of just 125 bps. In contrast currently the US is close to zero (officially the overnight target is 0 to 0.25%), while RBI is at 8%, a differential of nearly 800 bps.

Hence, we recommend having the fixed income portion of the portfolio comprising of both accrual and duration strategies where accrual strategies will lock into current high interest rates and duration strategies will start benefitting once the interest rates start coming off over the next 12-24 months.

Gold:

Demand for Gold has seen a rebound in recent days in India and China. India celebrated Diwali, the biggest gold buying festival  which boosted physical demand for the yellow metal on support of low prices. Meanwhile, a surge in Gold imports pushed up the India’s trade deficit for September to $14.25 billion of which Gold imports accounts for $3.75 billion. This raises questions on whether there can be some quantitative restrictions or higher import duties put on gold , to bring down the demand. Hence, allocating only a smaller portion of your portfolio in Gold continues to be a prudent strategy.

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RBI has , last night, once again introduced measures to tighten liquidity, so that the fall of the rupee can be controlled by removing liquidity for possible speculation on the rupee. Whilst this may seem like a localized response to many and unique to India, it is important to note that similar measures have been announced in Turkey, Brazil, Indonesia and China in different forms. Bond markets in India have reacted sharply to these tightening measures and are likely to do so every time these measures are announced. However, it is important to look at this from a historical perspective as the widely held view is that these measures are temporary in nature. If one looks at past measures of currency defence by the RBI, and the resultant measures and periods that it takes to reverse such measures, it provides some interesting insights. Four periods have been considered here:

1. 2011-12, when the rupee depreciated after the emergence of the Euro crisis and the US debt downgrade.

2. 2008, during the period of high oil prices and the global financial crisis.

3. 2000, post the tech bubble bursting

4. 1998, in the aftermath of the Asian financial crisis

PERIOD

DATE OF MEASURE

RBI’s ACTION

BOND YIELD IMPACT

REVERSAL DATE

PERIOD RUN

1998: Asian Financial Crisis

Jan 1998

· Increase in bank rate by 200 bps· Increase in CRR by 50 bps · Immediate increase in yields· But within 1 month yields decreased though it took a few months to fully normalize Mar 1998 · Policy: Approx. 2-3 months· Bond Market: 1 month
2000: Tech Bubble

July-Aug 2000

· Increase in bank rate by 100 bps· Increase in CRR by 50 bps, 25 bps immediately reversed · Immediate rise in yields· Yields peaked by Nov 2000

· But reached a new low within 6 months

Feb-Mar 2001 · Policy: Approx. 6 months· Bond Market: 2-3 months
2008: Global Financial Crisis

Jun-July 2008

· Increase in repo rate by 125 bps· Increase in CRR by 75 bps · Immediate rise in yields, however rates peaked before the last rate hike· Yields set a new low within 2 months of rate hike Oct 2008 · Policy & Bond Market:Approx. 1-2 months
2011-12: Aftermath of the US Debt downgrade

Sep-Dec 2011

· Increase in FCNR & NRE rates· Increase in repo rate by 100 bps · Yields peaked in Nov 2011bu reversed all losses by end Dec 2011· But reversed all losses by end of Dec 2011 · CRR cut in Jan 2012· Repo rate cut in April 2012 · Policy : Approx. 6 months· Bond Market: 2-3 months

Source: Bloomber,RBI, Axis Mutual Fund

As you will see from the data above, whilst bond markets sold off in response to RBI measures, bond yields typically peaked very soon after the policy actions and resumed the downward trend soon after. The total period of the bond market stress was 1-3 months, whilst RBI itself reversed the measures within 2-6 months. Thus, all these measures were temporary and were reversed when it became apparent that the impact on the domestic economy was worse than the marginal impact on the exchange rate.

Therefore, from an investor perspective, it is important to view your holdings in bonds and bond funds keeping this perspective in mind ie if you have a short term holding period, you need to be concerned about the volatility, but if you have a long term horizon, and are using bonds and bond funds as a part of your overall asset allocation strategy, you should look at these opportunities to buy into this volatility over the next few months.

Of course we should not forget what Warren Buffet once remarked “If past history was all there was to the game, the richest people would be librarians.”

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Whilst the expectations from the budget were low, many of us were hoping that the budget would try to push the envelope since it was the last real opportunity for the UPA government to push through reforms. However, it seems like the government did not try to do anything dramatic, lest Mamta insists that the Finance Minister should resign, along with the rail minister.  So we will celebrate Sachin’s 100th 100 today instead of the budget.

The early assessment of the budget and what’s in it for you:

Your Income

  • Gender equality is one step closer in India, at least as far as tax laws are concerned. The minimum  tax exempt income slab is now Rs. 2 lakhs for both men and women.
  • The Direct Tax Code (DTC) has been deferred. There has been a marginal tinkering with the tax slabs, with income upto Rs. 2 lakhs  being exempt. For the Rs. 2 – 5 lakhs slab, tax rate is 10%, and 20% for the next slab of Rs. 5 – 10 lakhs. The highest tax slab now starting at an income above Rs. 10 lakhs is to be taxed at 30%. Whilst this is clearly not a significant rationalization in the taxation rates on personal taxes,  it aligns it with the proposed DTC so we are hopefully a step closer to the DTC.
  • For anyone in the highest tax bracket (earning above Rs 10 lakhs), expect a saving of Rs. 22600.  It is important to ensure that you put this saving to good use i.e. to your highest priority financial goal.
  • Exemption of an amount of Rs. 10000 for interest earned on savings accounts. In addition to some marginal savings, the biggest advantage is probably the administrative ease that comes with knowing that if you manage your savings account without excessive balances, you are saved from running around to collect your interest certificates for savings accounts at the end of the year from multiple banks.

Your Expenses

  • If you have a marriage coming up soon, be ready to pay more for gold and silver. Customs duties on gold and silver have both been hiked.
  • Cars will become more expensive with an excise duty hike, and yes, it does not matter whether the car runs on diesel or petrol, for now.
  •  Expect prices of consumer durables to go up – TV, Acs, refrigerators, washing machines and microwave ovens could be 2-4% more expensive.
  • Expect to pay more for most services for e.g. telephones, as service tax has been raised from 10% to 12% and most services except 17 are now covered under the ambit of service tax.
  • You  can expect a deduction of Rs. 5000 for a preventive health checkup
  • Expect inflation to creep up once again as the government continues its borrowing program unabated – plans to raise a gross borrowing of Rs 5.7 lakh crores this year. Interest rates may therefore not come down as quickly as a lot of people expected.

Your Assets and Liabilities

Equity Assets

  •  Another new program named after Rajiv Gandhi ( no one wonders why?) allows retail investors with income upto Rs. 10 lakhs to get a 50% tax deduction on investments in equities upto Rs. 50000, with a 3 year lock in. This should help in increasing retail participation in equity markets to a certain extent.
  •  While equity markets may be driven in the short term by reactions to the budget , we believe that the markets  will ultimately be driven by global oil prices and liquidity flows from overseas. The markets are already pricing in a large portion of concerns like input cost inflation and higher interest rates. Since valuations are currently still attractive, look at enhancing equity exposures on declines vis a vis your overall asset allocation strategy. Expect returns to be in line with long term corporate earnings growth of 15-20% per annum over the next 3 years.  A key factor to watch out for will be tensions in the Middle East, which can take oil prices higher.
  •  The Securities Transaction Tax (STT) has got lowered by 20% which may be marginally beneficial for investors.

Fixed Income Assets

  •  The expected government borrowing numbers and slippages on the fiscal deficit front are negative for long term yields and bonds. We therefore believe it is prudent to remain at the shorter end of the yield curve i.e. in the 1-3 year product , with a 6 to 9 month view.  The use of short term bonds funds and Fixed Maturity Plans ( FMPs) is recommended.
  •  Enhancements in tax free bond limits like NHAI, HUDCO, IRFC will probably result in more issuances in this space, which should be good for investors in the highest tax bracket.
  •  With Qualified FIIs allowed to access corporate bond markets, that should result in increased liquidity in corporate bond markets over a period of time.
  •  You could expect to pay more for insurance policies as well due to service tax increases.

Real Estate Assets

  •  Tax deduction at source has been introduced on sale of real estate ( except agricultural land) at the rate of 1% with effect from Oct 1, 2012. This applies to all transactions above Rs. 50 lakhs in specified urban areas and Rs. 20 lakhs in other areas. Since property registration will not be permitted without proof of deduction and payment of this TDS, it could increase paperwork.

Loans and Liabilities

  •  With interest rates likely to come down slowly due to inflationary concerns and high government borrowing, prepaying your loans may continue to be an important component of managing your finances. Of course, if you have a cheap fixed rate loan, you can let it be as is.

Author – Vishal Dhawan, CFP CM

Disclaimer : This document and the information contained therein is strictly confidential and meant strictly for the selected recipient and may not be copied or modified or transmitted without the consent of Plan Ahead Wealth Advisors Pvt. Ltd. This report is only for information purposes only and nothing should be construed to be of any investment advice.

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OVER THE last few weeks, the Indian equity markets have moved down very sharply with a large number of stocks and sectors having lost even more than the index. The mood has changed from extreme optimism to worries about the sustenance of the India growth story on the back of concerns around higher oil prices due to the disturbances in the Middle East, food and commodity inflation, higher interest rates, corporate governance amongst a host of other factors.

Since fixed income returns having also become much higher over the last few weeks with banks raising deposit rates and Fixed Maturity Plans ( FMPs) offering the possibility of attractive returns, vis a vis equities that have been consistently losing value, the temptation of moving out from equities lock, stock and barrel and into fixed income is obviously very real.

Whilst it is always tempting to exit from your entire equity portfolio and reenter at a lower price, the successful implementation of a strategy of this kind of selling higher and buying lower has a very low probability of success.

Fixed income instruments have never worked well as inflation hedges in the past, so a fixed income oriented strategy is unlikely to be appropriate. So what should be done:

  • Equities as an asset class tends to be very volatile over short periods of time. In fact, historical data indicates that equities tend to return negatively over one year periods one third of the time. However, the returns over longer time frames tend to even out. In spite of all the volatility that we have seen over the last many years, the ten year returns on the BSE SENSEX are still in excess of 15 per cent per annum.
  • If your financial goals are less than three years away, it may be prudent to exit equities in spite of the correction. Ask anyone who bought equities three years ago in the second half of 2007 the broad markets have delivered close to nothing for the last three years.
  • Markets tend to move between points of extreme pessimism and optimism and as a result can end up being either cheap or expensive. It would be prudent to pare the tactical part of your portfolio during the expensive phases keeping the core intact as returns from equities tend to be concentrated around short periods of time.

Since it is extremely difficult to identify these periods before hand, you do not want to be sitting completely out of equity markets when the markets move up. Similarly, use the periods of extreme pessimism to enhance your tactical expo-sure to equities.

  • If there are names of stocks and mutual funds that you would not be comfortable with if the markets correct further, pull out of them before you panic sell. Hold the high quality names.

This article was written by Vishal Dhawan, CFPCM and appeared in the Deccan Chronicle  on  5th  February  2011 .

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WITH INDIAN equity markets being volatile over the last one month, and banks raising interest rates very sharply over the last few weeks, it is very tempting to move out of uncertainty in equity markets to the stability of the familiar bank deposit. The fill it, shut it, forget it syndrome could make investors move back to the comfort of bank deposits, especially with interest rates on the upswing and the high level of predictability of maturity amount that bank deposits offer.

However, we believe that this shift from equity to fixed income should not be driven purely by the rise in interest rates, especially in an environment wherein inflationary pressures continue to be significant both due to domestic and inter-national events.

Empirical evidence indicates that high inflation tends to accompany high growth, so don’t be surprised by inflation rates that tend to be higher than historical averages.

Your fixed income portfolio which has traditionally tended to give you a negative real rate of return after accounting for inflation, therefore needs to be combined with assets that tend to give you a positive real rate of return like equities and real estate. The overall decision on equity and fixed income mix needs to be driven by multiple variables like time to realisation of financial goals, overall asset allocation plan, current underweight/ overweight position for equity/fixed income amongst other items. Your financial planner should be in a position to advise you about this.

Once you have arrived at the appropriate mix of fixed income and equities, we believe that the current environment seems to have an anomaly wherein short term rates and long term rates have converged. In fact, in some cases short term rates are higher than longer term rates. We believe that this anomaly may not be a long term phenomenon and has been caused by a liquidity crunch that should start to ease over the next couple of quarters. Keeping this situation in mind, we believe that it would be a good idea to consider locking into products that are of a shorter term nature for a larger portion of your fixed income exposure, rather than longer term products. You could consider the use of:

■ Short Term Income Funds — Most individual investors tend to consider mutual funds only for their equity exposure. For investors who are willing to digest short term volatility and mark to market impacts on their fixed income port-folios, it could be a good option for investors to consider short term income funds from mutual funds as they are currently running attractive accruals on their portfolios.

Please have a look at the portfolio carefully before you put monies into these funds so that you are comfortable with the ratings and risk profile of the underlying portfolio.

  • Fixed Maturity Plans (FMPs) — These offerings from mutual funds would typically be available for periods of three months, six months and one year. Considering the tax arbitrage that they offer, especially for investors in the highest tax bracket, these could be excellent options to consider in the current tight liquidity environment.
  • Bank deposits — For investors with unpredictable cash flows and liquidity that may be required at any time, it may be prudent to consider bank deposits even though they would probably offer at least 1 per cent lower than comparable FMPs, due to the liquidity that they offer.
  • Corporate deposits — Shorter term options in this category could be considered, as they may offer marginally better rates than a bank deposit.
  • However, since these are unsecured, the quality of the corporate is critical.

This article was written by Vishal Dhawan, CFPCM and appeared in the Deccan Chronicle  on 11th  December 2010 .

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