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RBI in its monetary policy review earlier today, decided to keep rates unchanged as expected by most economists and the financial markets. However, he did provide some interesting insights that could impact your personal finances.

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Your investments

Whilst it maintained status quo, it indicated that there could be an upside risk to inflation, as has been evidenced in the last couple of months. A good monsoon, higher oil and commodity prices and consumption demand driven by the 7th pay commision could drive this upside risk to inflation. Whilst it maintained that the policy would continue to be accommodative ie there could be a possibility of rate cuts going forward, this will be driven by data going forward. Thus, adding exposure to fixed income portfolios dependent on the falling interest rates may need to be tempered, and accrual and short term/mediumd term strategies may be more suitable to lock into current yields. On the equity front, whilst consumption driven growth could be positive and an early signs of a recovery are evident , significantly higher oil prices and inflation could start to impact corporate earnngs that are just starting to show early signs of a recovery. Adding exposure to equities will also need to be tempered with slowing global growth data. Thus, a blended portfolio of equities bought with a long term view, and fixed income focussed on accrual strategies is most suited in this environment. The rupee could be negatively impacted by the potential outflows on account of FCNR maturities in September, and the intense debate on whether or not Rajan will get a second term as RBI governor.

Your loans

Since it has only been two months since the Marginal Cost of Lending Rate has adopted by banks, it will take some more time for RBI to be able to evaluate its actual impact on the ground. As per early observations, the transmission on the ground via cut in lending rates by banks has been slower thus far, but increased pressure on banks for tranmission is likely to result in this happening faster going forward.

What did RBI do?

The RBI in its policy review kept rates unchanged with Cash Reserve Ratio at 4%, Repo rate at 6.50% and Reverse repo at 6%.

On the liquidity front RBI had said it would provide some durable liquidity in the last policy review which was held in April and it did as promised. RBI will continue to provide liquidity as required in the system. RBI had also mentioned last time that there is an intention to move from a liquidity deficit to a liquidity neutrality position. RBI has not attached any time line to it and said it will depend on the market.

The FCNR B deposits that are due to mature in September have been matched with forward positions. RBI will intervene if excess currency fluctuation happens. On the issue of cleaning up of books of banks RBI mentioned that it will not reverse its action and will stick to its original target of March 2017.

What to expect going forward

Further policy action will depend on inflation numbers, oil prices, US Fed actions  and monsoons which are expected to be above average. Also withthe governor’s term with RBI ending in September, there is no clear indication whether he will continue for another term. This is likely to continue to be an area of intense debate till finally settled, which is unlikely immediately.

Watch out for the next policy on 9 August 2016.

 Image credit: www.canstockphoto.com

 

 

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Over the last few months, India has been in the news for a lot of reasons that have not exactly been flattering – corruption scandals, high deficit numbers, a sharp fall in its currency, a decadal low in terms of GDP growth, etc. All of this negative newsflow had made investors wary of investing in India and Indian equities, with most investors getting comfort by being in fixed income, real estate or gold. In spite of the sharp correction in gold prices, a large number of investors are viewing this sharp correction as an opportunity to add gold, rather than looking at it as a possible indication of the end of a decade of supernormal returns from gold.

We strongly believe that it is time for investors to start looking outside this comfort zone , that is, look at equities for four reasons:

Number 1, Low valuations – With forward earnings in the region of 1.3 to 14 times currently, we think that there is great merit in investors looking at what has happened in the past, when markets have been in these valuation zones. Investors buying into these valuation levels have in the past been rewarded with significant returns over the next 3-5 years. Whilst it is very common to hear that investors in the last 3-5 years have not made money in equities, we need to remember that valuations 5 years ago were closer to 20 times forward earnings, and therefore the advantage of investing in a low Price to Earnings environment did not exist at that stage.

Number 2, Sharp fall in gold prices and other commodities – A significant portion of the deterioration on the current account deficit has been on account of higher gold imports. With 1 year returns on gold now being negative and 2 years returns being in line or lower than bank deposits, we believe that it is only a question of time before investors start to question the future prospects of gold. We believe this is very common as most investors tend to look at returns from a rear view perspective, and just as they are uncomfortable with buying equities, because of its poor performance in the last few years, this is likely to start showing up with their gold purchases slowing down as well. Lower demand for gold should be good news for India’s current account deficit and currency.

Number 3, Low correlation between election years and stock market returns – Data from the past election years or the year before election years, do not seem to show any evidence of a strong correlation with equity market returns. In fact, if anything, equities have tended to do very well in these periods. Thus, we believe that the fear of uncertainty around elections is already priced significantly into markets currently, and investors with a 3-5 year view should be focusing more on low valuations and less on guessing the outcome of the election, especially if data from the past indicates that election outcomes do not have a high correlation with equity market returns.

Number 4, Majority views do not work with investment portfolios – Investor portfolios tend to get polarized towards particular asset classes due to high returns in that particular asset class. For example, most portfolios we see today are significantly overweight gold and real estate. Fund flow data ie where the majority is investing, has tended to show that the majority normally gets it wrong, and strong outflows from a particular asset actually make it a good time to buy. The significant outflows from equities over the last many months and years, and the low level of conviction, in our view are strongly indicating that there is every chance that the majority are going to get it wrong again and wealth is going to get created for those who open their eyes to equity today and build it to add up to a meaningful part of their wealth over the next six months to one year.

The biggest risks to this outlook come from high oil prices, so if I was an investor wishing to get wealthy today, I would keep my eyes wide open to see what is happening to oil globally. High oil prices are therefore your biggest risk to getting rich.

I urge everyone who does not have a meaningful exposure to equities to open their eyes to this opportunity to get wealthy, that seems to be available for those who wish to take it for the next 3-5 years.

The windshield of a car is many times larger than the size of its rear view mirror, so that the driver can focus more on the road ahead, with the rear view mirror being used sparingly. Unfortunately, in an investment portfolio, the rear view mirror gains more importance than the windshield, which can be very dangerous for the driver. Look at equities through a windshield, and not through the rear view mirror.

I cannot help but quote Sir John Templeton here – The time of maximum pessimism is the best time to buy.

 

Disclaimer : This communication is for informational, financial literacy and educational purposes only. This communication should not be construed as financial advice.

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