Urjit Patel does a Raghuram Rajan……stamps his independence

Whilst there was a consensus view of RBI cutting repo rates today, with only the extent of the rate cut being questioned (would it be 0.25% or 0.5%?), Urjit Patel or rather the monetary policy committee (MPC) sprung a surprise by keeping rates unchanged. Both equity and bond markets reacted negatively to this as they were pricing in at least a 0.25% cut.

RBI was probably concerned by multiple factors – volatility in global financial markets that could be caused by a Fed rate hike, issues in the Eurozone, oil price rises, and the potential stickiness of consumer inflation around non food components.

One needs to remember that inflation targeting continues to be the core role of the RBI moving forward, and any risks to inflation are likely to result in a more conservative approach, tilted towards managing inflation in the inflation growth trade off.  In addition, the focus towards management by data is a significant positive, as markets can sometimes allow emotions to override incoming data, that may be to the contrary.

Your investments

The demonetisation impact on the Indian economy continues to be rather speculative in our opinion, with a very wide range of possible outcomes,. and data around the same is likely to continue to throw up surprises. For example, we have seen over the last few weeks, the quantum of cash deposits that have come back to the banking system have been significantly larger than originally anticipated. In light of the need to take portfolio investment decisions basis data, it may be prudent to look for broader trends to capture through your investment strategy for example fixed income products continue to offer a real rate of return in the region of close to 2%, continuing to make fixed income investments an attractive option. With liquidity continuing to be significant, it would be prudent to look at locking into current interest rates, through a combination of accrual oriented short term and medium term funds, tax free bonds and to also cover reinvestment risk. A portion of the fixed income allocations can continue to be allocated to taking the benefits of falling interest rates, by investing into dynamic bond funds where the fund manager has the flexibility to move portfolio durations driven by incoming data. Equity investors may need to enhance exposures gradually through a combination of rupee averaging and value averaging strategies, as the potential slowdown on the back of a US rate hike and a consumption slowdown driven by demonetisation, is balanced by possible liquidity flows from Japan and the EU, as well as equity prices, especially of large cap indices, now at levels much closer to fair value after the recent correction.

Your loans

With the expectation of cost of funds for banks coming down post demonetisation, banks’ lending rates are likely to continue to slide further down. Since April 1, 2016, when the MCLR was introduced, most banks have been reducing it gradually as their cost of funds came down. The huge inflow of funds post demonetisation could make them cut MCLR  further. Thus one can expect loan rates to continue to head downwards, creating some additional consumption or investing surpluses for families with loans.

Way Ahead

The RBI is clearly aware of the danger to the GDP growth rate and possible liquidity outflows, driven by the twin impact of demonetization and higher interest rates in the US. Thus a wait and watch policy may actually be a great idea. Whilst everyone will await the next policy on Feb 8^th, one needs to remember that action by the RBI can also be done prior to that if necessary, and therefore should not be ruled out. After all, surprises and the independent nature of the RBI are back in fashion.

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What does the 0.25% rate cut announced today mean for you?

In its first Policy the Monetary Policy Committee (MPC) headed by newly appointed RBI Governor Urjit Patel cut policy rates by 0.25% taking repo rates down to 6.25%. The way rates are decided is different from what it was before. It is now a 6 member committee which decides rates instead of the Governor alone. The MPC was unanimous in their decision to reduce interest rates by 0.25% today.

Focus on the real rate of return

With interest rates falling, there is a tendency to want to take more risk on the portfolio to achieve a higher absolute rate of return. We think that it is critical that investors focus on real rates of return ie the return after inflation on their portfolios. RBI continues to want to keep real rates of return between 1.25% and 1.5%, which makes fixed income attractive, even if you generate a lower return that what you generated a few years ago. Avoid higher risk strategies in chasing a higher rate of return in the current environment.

Your Investments

The rate cut came largely on the back of improved inflation numbers close to 5% in August compared to close to 6% in the month of July. Whilst food inflation, which was a big driver of inflationary pressures, seems to have come off very sharply, there continue to be risks of higher inflation due to the impact of the Goods and Services Tax (GST) post the announcement of the GST rates by the GST Council, the Seventh pay commission and the merger of the railway budget and the Union Budget which could impact the fiscal deficit by 0.15 to 0.25%. With an inflation target of of 4% +/-2%, the inflation numbers seem to be well under control at this point. The bond and equity markets had already priced in this 0.25% rate cut and thus they did not react aggressively to this announcement. Thus, whilst there continues to be a 0.25% rate cut possibility from here onwards, the timing of the same will be driven by other data, including what happens globally with interest rates. With growth rates continuing to become healthier in India, equity markets may continue to hold up in spite of their premium valuations at this point, as earnings could continue to be supported by lower interest costs. Therefore, the strategy would be to use a combination of domestic and US equity along with bond funds, with the bond fund exposure being weighted more towards accrual and short term strategies, and less towards duration and dynamic strategies. On the liquidity front RBI policy remains accommodative and nothing has changed on that front.

Your Loans

The loan rates get decided by Marginal Cost of funds based Lending Rate (MCLR). The transmission that has happened is lower than what everyone had expected. Therefore on the loan side you could continue to expect some relief, though it may be lower than what is expected.

Way Forward

The December policy will, to some extent, depend on the data flow and market expectations of the US Federal Reserve decision on hiking interest rates or not. Let us watch for the next RBI policy on 6 December 2016.

Image Credits: www.canstockphoto.com

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Is China’s pain really India’s gain?

Asia’s biggest economy & the world’s second largest economy is slowing, the Federal Reserve is about to kick off an interest rate tightening cycle, and China has just devalued its currency. Is this the repeat of Asian Financial crisis we saw in 1997? There are certainly parallels, but important differences as well. This time around, Asian economies have stronger current account balances, fiscal positions and foreign exchange reserves that provide a thicker buffer against turbulence. In addition, the exchange pegs that existed at that point have seen significant changes as well.

China’s Yuan devaluation comes on top of a steep slowdown in the world’s second-biggest and Asia’s biggest economy (Japan was No. 1 back in 1994) and a commodities slump that is hurting nations from Brazil to Australia, Malaysia and South Africa. Chinese companies now threaten to displace exports from Asian and emerging market competitors just as the U.S. Federal Reserve prepares to raise interest rates for the first time since the global financial crisis.

Analysts have also questioned China’s growth outlook although it posted economic growth of 7% year on-year in the second quarter, unchanged from the first quarter. They point out that Chinese growth cannot be sustained in the second half of the year given the exports decline and the drop in financial services’ contribution to the economy following the Chinese equity rout. They said a lot more may be needed to achieve this year’s target growth rate of 7% for the economy, given the weaker-than-expected macroeconomic data in recent weeks. To-date, Beijing has cut interest rates four times since November and also reduced the amount of money that banks need to keep with the central bank. Also, large infrastructure projects continue to have funding. However, the good news is that falling real estate prices in China, which were seen as a very big threat, have started to stabilize.

Let’s take a look at why is this happening? After the sub-prime crisis in the US and the steep fall in markets following the Lehman Brothers bust, the world has tried to solve the problem by throwing more and more money at the problem – money printed and lent out at near zero interest rates almost all over the developed world.

The US, after seven years of grappling with the problem, is still making only intermittent noises about raising interest rates; if the markets continue to crash and the global economy slows down, it may yet chicken out; Europe is keeping near zero rates in the hope growth will revive even as Greece is trashing about for survival; Japan kept the money-printing presses working overtime for more than a decade, but has, under Shinzo Abe, gone back to the same trick of monetary expansion.

The Chinese are unable to grapple with the new challenges that come with becoming the world’s second largest economy and key driver of demand. Two issues are paramount: one, there is huge financial repression, where Chinese savers are paid low returns and the cheap money raised from them has been invested uneconomically in unwanted infrastructure; and two, while financial repression helped fund investment-led growth over the last three decades, today it is constricting consumption – which is what China needs to boost internal growth.

India could use the opportunity provided by China’s problems to get its own growth engines revving. The tumult in China’s stock markets has turned into a blessing for Indian shareholders. Investors who poured into India in 2014 pulled back this year over concerns about taxes and the slow pace of reforms, preferring markets such as China, Taiwan and South Korea..

Now, fears about Chinese stock market volatility and Beijing’s interventions are overriding those concerns and driving them back to India. In this way India can have a much bigger pie of global capital which it can use to fund infrastructure requirements.

We find India a good alternative, given its improved macro data.

On the inflation front, a fall in both Consumer Price Index(CPI) and Wholesale Price Index (WPI) continued. CPI based inflation in July decreased to 3.78% from 5.4% in June 2015 due to a higher base last year. WPI fell for 9^th consecutive month to -4.05% from -2.4% in the previous month. India is gaining from cheaper commodity prices. Cheap global crude and commodity prices mean that the imported component of inflation will also be lower. In fact, its impact is clearly visible in the wholesale price index, which has been showing negative growth for nine consecutive months now, mainly due to high deflation in minerals and mineral oil. India imported $139 billion worth crude and petroleum products in the 2015 fiscal, and as a rough rule of thumb, every $1 drop in crude prices results in a $1 billion drop in the country’s oil import bill. This will be good for reduction in India’s Current Account Deficit. India also imports $3 billion of copper and copper products. Also, lower input costs translate into higher profit margins for many Indian corporates. This will be a major respite for them. Due to depressed domestic demand, they had been struggling with their pricing power over the past few years, and were not able to pass on the increased cost.

With the government of India focusing on “Make in India,” this may be the time to provide impetus to manufacturing and even invite Chinese companies to set up a manufacturing base in India. However, this may require fast-tracking several pending economic reforms and easing the norms for doing business in India.

The Indian rupee has also been relatively stable over the last couple of years, vis a vis other emerging market currencies. This relative stability of the Indian currency, adds comfort to investors looking to invest in India.

Last but not the least, whilst most parts of the developed world are currently sitting on record low interest rates, India is one of the few countries which can potentially see interest rates getting cut, making it attractive for both companies to begin their investment cycle, as well as improve margins for corporate India going forward.

All in all, China’s pain could be India’s gain, but it won’t come easy. After all, there are no easy roads to success, doors only open to a combination of hard work and the constant desire to get better.

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Our Market Mantra for December 2014

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:

Source:  IMF, credit Suisse Research, Dec 2014

3. 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.

Source:  RBI, Citi Research, Dec’14

4. 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.

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

5. 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.

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.

6. 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.

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.

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.

7. 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.

8. 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.

9. 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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Market Mantra November 2014

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.

Source:  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.

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.

Source: 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:

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.

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%.

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:

Source: 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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Market Mantra December 2013

December was a month of expectations being different from reality. There was a widely held view that tapering in the US would be deferred for a while, till the new US Federal governor Janet Yellen settled down into her new role. However, after keeping investors guessing for several months on when and how much the US Federal Reserve will taper its $85-billion-a-month bond buying program, the Federal Open Market Committee ( FOMC ) finally decided to start tapering its third round of quantitative easing by $10 billion a month from January 2014 onwards. FOMC made this decision because of the reduction in unemployment since the start of QE3 (quantitative easing) and the stronger non-farm payrolls in recent months. Of course, this means that the US recovery is well on track now, and that is good news for the global economy, considering the significant size of the US economy and consumer.

In India, the widely held view was that continuing his fight against high inflation, Raghuram Rajan would increase interest rates once again to quell inflationary expectations. However, Rajan surprised the markets by maintaining status quo, though he kept his options open, including discussing the possibility of a hike between policy meetings if the data so warranted.

Domestic Equities: The Indian Equity markets saw various ups and downs in 2013 on account of FED tapering concerns and general elections.

For the year to 26th December, BSE Sensex Index gained approx.  8.50% where CNX Midcap lost close to 6 %.

Recently concluded elections of 5 states (MP, Rajasthan, Chattisgarh, Delhi, Mizoram) have seen big gains made by the BJP at the cost of Congress. This has enthused investors as it improves the odds of a likely stable government at the centre following the next general election in 2014. The surprise element of the Aam Aadmi Party (AAP) winning a disproportionate share in Delhi and thereby forming a government, augurs well for the democratic credentials of India.

The last time around, the Fed tapering created its own challenges and volatility but India looks much better prepared now for Fed Tapering due to following factors:

1. Current account deficit for FY14 is likely to be around 2.7 percent of GDP, much lower than.
2. FII INR debt holding is lower at $20Bn v/s $37Bn than in May 13.
3. Accretion of USD 34 billion through FCNR bank deposits against a targeted USD 15 to 20 billion
4. Lower oil prices and inclusion of Indian government bonds in JP Morgan Government bond Index- Emerging Markets are other potential  positives.

Indian Rupee: The Rupee went through a sharp correction in 2013 on Fed-taper concerns. Recent months have seen much more confidence on the government’s ability to manage the funding shortfall and hence a return in stability of the rupee, as the Rupee valuation has become supportive and the Current Account Deficit (CAD) has come down sharply. Markets are expecting the Rupee to be much more stable in 2014 even as Fed carries out its tapering of QE. Inflation differentials between the US and India will continue to drive the value of the currency moving forward, even though there may be shorter term deviations using this model.

Gold:  Gold prices remain under pressure due to both fundamental factors (normalization in US interest rates) as well as technical factors (redemptions from gold ETFs). Gold continues to be an important component of an asset allocation strategy, and should be maintained at 5-10% of the overall portfolio.

On Fixed Income: Year to 26th December, 10 Year Government security yield lost close to 14 percent.

The annual consumer price inflation rose to 11.24 percent in November from 10.09 percent in October, driven by food prices. WPI Inflation rose to 7.52 percent in November from 7.00 percent in October. Hence, it was expected that the RBI may once again raise the repo rate in the monetary policy review on December 18, 2013 which is currently at 7.75 percent. But, RBIs move to keep rates unchanged surprised the markets as it came in contrary to consensus expectations of at least 25 bps hike. However, RBI has chosen to wait for more data as there are indications of vegetable prices turning down sharply as well as the weak state of the economy.

Key drivers of Improving Interest Rate Outlook:

Inflation – sharp moderation likely in Year 2014

CAD (% of GDP) – sharp improvement (2.7% in FY14E Vs 4.8% in FY13)

CAD Deterioration was led mainly due to rising gold imports (2.9% of GDP in FY13 Vs 0.5% in FY08).

Fiscal Deficit Improvement: diesel subsidy is the key.

Yield Spread between Indian 10yr G-Sec Yield and 10yr US Treasury Yield is @6% Vs long term (10yr) average of 4.1%.

Summary of Interest rate drivers – Outlook

All the above indicators point towards lower interest rates in CY14. Thus adding some component of longer term bonds and duration/income funds can be considered with a 18-24 month view.

US Equities: For the year to 26th December, Dow Jones and Nasdaq gained close to 26 percent and 41 percent respectively. Whilst it has been a spectacular year, the outlook on US equities continues to be positive. However, we are unlikely to see returns in 2014 anywhere close to what 2013 provided. Building a globally diversified portfolio across the US, Europe and Asia continues to be strongly recommended.

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Do NRIs need a Financial Plan

From our experience of interactions with nonresident investors, we have found that a significant number of investments by NRIs tend to be made during their short visits to India.

During that period, when they visit their bank or speak to relatives/ friends, they get a broad view on what is happening to various asset classes – be it real estate, stock markets, or bank deposit interest rates. Between the various social obligations, time with family, and other things to do in their action packed agenda, quick investment decisions tend to be made, a large number of which tend to be long term commitments through investments in long term insurance policies/ real estate investments. Unfortunately, a large number of these investment decisions are not necessarily aligned to long term financial goals of the NRI and his family. Once NRIs return back to their home overseas, they then tend to wonder if it was the right investment decision or whether haste made waste, especially as they now get time to think about it. They wonder whether these investments fit in case they wish to return to India at a latter point in their lives or in case they wish to use these investments for children’s education or their own retirement, or to support their family members back in India.

In addition to the alignment to financial goals for self and family, it is critical to ensure that the investment products chosen allow non residents to invest in them, the repatriation restrictions (if any) on the principal amount and the gains, as well as the taxation of the gains in both India as well as the overseas location of the NRI. A lot of these answers can only be obtained when there is clarity in terms of what role the investment is expected to play for the NRI in his portfolio.

It is therefore critical to ensure that the focus on working to a financial plan is given the same degree of importance, irrespective of whether the individual is a resident or a non resident. In fact, working to a plan tends to be even more critical for a non resident than a resident, due to a legacy holdings and finances that they may have from their days in India.

A very large number of NRIs tend to leave India during a phase of their life when they have already begun their financial life – they have probably opened regular savings bank accounts in their names, bought investment products like stocks/mutual funds/insurance products/PPF accounts, or even made a real estate investment. Since there is a tendency to leave India on an overseas assignment/project, a higher education and then decide to settle down overseas, the starting point for a financial plan is to get your existing portfolio of investments in order.

 

The following steps need to be taken to ensure that the existing finances are aligned to the needs of a non resident

1. Close all resident bank accounts or convert them to nonresident ordinary (NRO) accounts. These NRO accounts can be used to credit amounts from investments that may have been made earlier, for example, dividends from stocks, rental income, amongst others.

2. Ensure that the tax returns in India have been filed. Whilst filing a tax return is not mandatory if the income is less than the taxable limit, it is important to be sure that the total income is less than the taxable limit.

3. Review your demat accounts so that they can be converted to nonresident demat accounts.

4. Change your mutual fund portfolios (if any) to a non resident status and link your NRO bank accounts to these investments.

Once the legacy portfolio of investments have been put into order, it is crucial to begin the process of setting up your financial goals through a financial plan. Whilst a financial plan may sound rather complex, it is simply a roadmap that allows you to think about what you want to achieve with your life goals and how your finances will allow you to get there.

Let me illustrate this with an example. Let’s say one of your life goals is to have your child study at a particular post graduate program. How would you design your financial plan towards this life goal?

1. Establish the current cost of the education that you want to plan for – The costs for higher education vary significantly depending on the type of college, country of education, type of program and number of years of education. The total costs of education should be established including the costs of living and travel and not just education costs.

2. Understand the impact of inflation on current costs – Inflation rates on education may vary significantly depending on whether you wish to plan an education in India or overseas. You need to establish the corpus required for the education after adjusting for inflation.

3. Choose the appropriate asset mix to achieve your target – It is critical to establish the right balance of stocks and fixed income exposure so that you understand the returns and associated risks that you will take on the portfolio in order to reach your target.

4. Choose the appropriate product/products to achieve this targeted amount – Once the above steps have been undertaken, you can move to the product selection stage where you can look at the merits/demerits of using deposits, mutual funds, insurance plans , stocks or other options to achieve your target.

5. Evaluate the progress towards your goal at regular intervals – It is important to review the progress of your financial plan to ensure that you are on track to achieve your financial goals. However, it is important that you give your products adequate time to deliver as per their designed objectives. A review once a year should be adequate.

A financial plan can be developed for all your life goals accordingly. You may need to take the help of a financial planner to integrate all your goals into a plan so that your overall finances can be aligned to all your goals. For example, your retirement plan could vary depending on whether you wish to finally settle down in India or continue to live overseas once you retire.

In addition to each of planning for your financial goals, you need your financial plan to cover:

1. Taxation of these investments in your home country – Tax treatment of investment products in the home country may be different from those in India. For example whilst there is no long term capital gains tax on equities or equity mutual funds in India, capital gains tax may be chargeable on these investments in the country that you live in. It is therefore critical to understand the tax implications at both levels 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, so that you are not taxed twice on the same amount. Your tax advisor should be able to help you on this.

2. Succession planning – Inheritance laws tend to vary from country to country. In addition, whilst India does not currently have any estate duties and taxes, a large number of countries have an inheritance tax. Since you could end up inheriting assets from your parents/ other family members and also having your assets transferred to your family members on death, it is critical to ensure that succession planning documents like wills are created keeping the inheritance laws of both countries in mind.

Once you are clear about your financial goals, taxation and succession laws, you will be in a position to pick your investment products far more easily and can focus on tracking how your investment products are taking you closer to your financial goals.

 

This article was written by Vishal Dhawan, CFP^CM 

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It’s that time of the year again – enjoy it and benefit from it

It’s that time of the year, when the mornings have a nip in the air in certain parts of India and come with fog in other parts. It’s that time of the year when I don’t go on my morning walk as it feels nice to lie in my cosy bed. Of course, I also don’t go for my morning walk in the rains as I may get wet and in summer as it’s too hot. It’s that time of the year to look forward to some good times with friends and family, as a large number of relatives and friends abroad make their annual or biannual visit to India. So it’s a great time to look forward to some exciting new gifts from overseas as well for all the little children at our homes.

As you spend time with your friends and family from overseas and savour the good old times and their favorite mithais with them, don’t forget to remind them how investing in India at this point could be an excellent opportunity. This could well be the best return gift that you can give them on their India visit this time. And whilst you are giving them their return gift by telling them about the India investment opportunity, don’t forget your own investment portfolio. Whats good for them is also good for you.

Whilst the falling India rupee has been a terrible advertisement for India in the last few months, with the fall in the Indian rupee against the US dollar being the sharpest amongst all Asian currencies, we believe that this makes India even more attractive for long term investors. Whilst there are concerns in India due to the higher current account deficit that India has as compared to other emerging economies, we believe that the current depreciation in the Indian rupee is only partly an indication of the weak current account and trade deficit of India. The other part of this depreciation is actually driven by the strength of the US Dollar, which has emerged as a relative safe haven as compared to other global currencies. This seems strange as the fundamentals of the US itself are currently under severe stress on the back of persistently high unemployment and debt and spending that continues to be significantly above comfort levels. However, financial markets are known to take extreme views of events and the liquidity that the US dollar provides could be the most important determinant of its value currently rather than the fundamentals of the US economy.

So why should you or your NRI friends and relatives invest in India?

1. Attractive Demographics – Whilst most parts of the developed world are struggling with aging populations and China is also facing the challenges of a one child policy that they have followed, India with a median population of 26 years has the benefit of an ever increasing workforce that is likely to consume everything including two wheelers, cars and processed foods.
2. High savings rates – Whilst rising inflation and EMIs have impacted savings rates to a certain extent , India still has a savings rate in excess of 30% and expected go grow to close to 40% over the next few years. Compare this to savings rates in other parts of the developed world of low single digits. This means that Indian businesses will continue to have access to a huge pool of money domestically to grow their businesses.
3. Interest rates in India close to peaking out – Whilst this could result in a temporary slowdown, we believe that these rates are unsustainable for long periods and may thus start to come down over the next year. It may therefore be a good time to look at locking into fixed income instruments that give you the benefits of high interest rates that are currently close to double digit and will also gain when interest rates start to come down.
4. Equity markets at a discount to historical prices – Whilst it is always tempting to try to time the entry into equity markets at its lowest point, we know of very few people who succeed at it consistently. Since stock markets are at a discount to long term averages currently, we believe this is an excellent opportunity to buy into good quality Indian businesses that are quoting at a discount either through stocks directly or through equity mutual funds.

Whilst it is tempting to put all the money into just one place due to the ease of managing it and the high interest rates, we believe that India provides an opportunity for building a good quality diversified portfolio at this point across both fixed income and equities. You may need the help of a financial planner to build an optimal portfolio.

It’s that time of the year again, when companies are on a discount sale in stock markets so don’t let the opportunity go.

It’s that time of the year, when interest rates are very attractive, so try to lock in for a long duration.

It’s that time of the year, when you want your visiting relatives and friends from overseas to go back with sweet memories of their India visit and your return gift of a great wealth creation opportunity.

And whilst you are playing the perfect host, don’t miss the wealth creation opportunity yourself.

This article was written by Vishal Dhawan, CFP^CM 

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Fixed income strategy – what to do now?

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, CFP^CM and appeared in the Deccan Chronicle  on 11^th  December 2010 .

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