Being right is more important than being popular

RBI has been proven right on its past decisions on interest rates, and in line with consensus views post the Budget, the Monetary Policy Committee (MPC) decided to keep the repo rate and reverse repo rate unchanged at 6 percent and 5.75 percent,respectively. The MPC also decided to keep the policy stance as neutral, and indicated that further rate hikes or rate cuts will depend on incoming data. It does seem like a long pause on interest rates is in store. The MPC voted 5-1 in favour of status quo, with one member expressing a preference for a rate hike.

Since these were in line with market expectations, both bond and equity markets had already priced in this scenario, and thus they did not react much to this announcement.

The CPI projections for inflation going forward were higher than projected in the last policy, with inflation expected to continue to be elevated at 5.1%p.a in Q4, and 5.1% -5.6% p.a, in H1 2018, due to pressure from higher commodity prices, oil and possible impacts of MSP hikes and increased customs duties, along with greater pricing power for companies to pass on these costs to end consumers.

Growth for 2017-18 is projected at 6.6% ( lower than 6.7% expected earlier) , and projected for 2018-19  at 7.2 %  overall. This recovery is expected on the back of better bank credit growth, an increase in capacity utilisation, GST stabilisation and bank recapitalisation.

Governor Patel ascribed the recent sharp rise in bond yields to various global and domestic factors; including higher US rates, oil prices, increase in inflation, cyclical pick- up in demand in the economy as well as fiscal slippages from the government.

 

Your Investments

With the RBI referring to a recovery in the economy, it does seem that whilst they will continue to track data closely, strategies that are focused on interest rates staying elevated should be the preferred choice.  Considering that real rates of return (returns from fixed return investments less inflation) continue to be significantly positive, we continue to believe that investing in fixed income is attractive, as equities continue to trade at significant premiums to long term price to earnings ratios in spite of the recent correction.  It may be a good idea to continue to have fixed income exposure through a combination of largely accrual, short to medium term, and hold to maturity strategies. Considering the bank recapitalisation, investors could also consider credit opportunities funds for a small portion of their portfolios. For investors willing to continue to look at interest rates having periods of downward volatility, dynamic bond funds that have the flexibility to move across bond maturities, can be explored for 10% – 15% of the fixed income portfolio.

 

Your Loans

Whilst RBI’s decision to hold rate cuts could indicate status quo on rates, we think that the rapid increase in bond yields and its negative impact on bank balance sheets could create upward pressure on loan rates, with banks possibly raising rates going forward.

Reserve Bank introduced the Marginal Cost of Funds based Lending Rates (MCLR) system with effect from April 1, 2016. With the introduction of the MCLR system, it was expected that the existing Base Rate loans shall also migrate to MCLR system. It is observed, however, that a large proportion of bank loans continue to be linked to the Base Rate. Since MCLR has proven to be a better tool to transmit interest rates, RBI has decided to harmonize the methodology of determining benchmark rates by linking the Base Rate to the MCLR with effect from April 1, 2018. This is likely to help borrowers who are still on base rate linked loans.  An ombudsman scheme to improve customer grievance handling for loans taken from NBFCs has also been introduced.

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As we shall say, so we shall do…

Sixth bi monthly RBI Monetary Policy FY17

The RBI monetary policy committee ( MPC ) reiterated what it has indicated in its last meeting in December – concerns around core inflation continue to remain with seasonal impacts on currently low inflation on items like vegetables likely to go away over a period of time, a strong global recovery that could create inflationary risks though higher prices of commodities including oil, volatility in global currencies on the back of rate hikes in some developed economies and some pass through of the HRA component of the 7th pay commission implementation.

Whilst none of this was really new, there continues to be a view that what the MPC says and what they will do are different from each other. With two consecutive policies that have reiterated the same thing, we believe that markets will finally believe that the MPC means what they say, and their actions will be consistent with the same.

It is therefore critical to continue to remember that managing inflation in the 4-5% pa range continues to be the number one priority of the RBI , and therefore decisions are likely to be taken keeping this in mind, more than other data points.

Your investments

The RBI also moved its policy stance to ‘ neutral ‘ from ‘accommodative ‘ which possibly means that the interest rate cuts from its side are probably coming to an end. This may mean that investment strategies that were driven around interest rate cuts need to be pared down. However, we need to remember that a neutral policy does not mean that interest rates are going to go up on bonds and fixed income instruments, so there is no need for a complete change in investment strategy on fixed income side. A strong global recovery as indicated in the policy statement ,is actually excellent news for the Indian economy, as a global growth environment has traditionally been positive for Indian companies, and therefore one should expect corporate earnings to get better going forward. The MPC has also indicated that they expect the economy to start showing a recovery going forward, so investments in equities could be enhanced for longer term investors. One also needs to remember that even thought RBI has probably stopped cutting interest rates, banks would possibly continue to cut loan rates as the transmission of the 1.75% rate cuts have only been about 0.85% to 0.9%, meaning that corporate India could continue to see lower loan rates going forward, helping their bottomline.

Your loans

With the banking sector flush with funds, and transmission only partially done, you can expect to see loan rates continue to drop for individual borrowers as well. It is a good time to refinance your loans, especially your home loan, in case you have not done so already. Be choosy about the loan provider that you use, as different variants of loans available could mean that you need to pick what works best for you.

April 6 is the next date to watch for the MPC meeting – expect some volatility in bond and currency markets till then, as they react to this shift to a neutral stance as well as other global events.

 

 

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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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Rajan’s swan song …… more of the same

Just like during the rest of his tenor, RBI Governor Raghuram Rajan avoided the theatrics and playing to the gallery with his last monetary policy. He maintained status quo on interest rates in today’s monetary policy review, much along expected lines. Going forward, whilst there will be a new RBI governor, policy decisions will be taken by a Monetary Policy Committee (MPC) and appointment of the members is under process for the same.

Your investments

Whilst the RBI governor did flag off some inflationary concerns due to the seventh pay commission impact, one could continue to expect a positive real rate of return due to a reduction in food inflation on the back of good monsoons. This could eventually bring down CPI inflation.The policy had an accommodative stance which means there could be a possibility of a rate cut going forward. On the domestic front there are a lot of positives like a pickup in Industrial production in May, indication of green shoots in manufacturing with Purchasing Managers and the RBIs industrial outlook indicating pick up in new orders, increased business confidence, Services sector PMI at 18 months high and early indications of a turnaround in exports. These should result in better corporate earnings in the coming quarters, supporting current market valuations which are a premium to long term averages.

On the FCNR (B) deposits maturity coming up over the next few months, RBI has said around 80-85% will be delivered through forwards and any shortfall will be adjusted from existing Foreign exchange reserves. They will intervene in case of increased volatility. The RBI will continue to support liquidity by conducting open market operations. With chances of falling food inflation on one hand and upside risk to inflation coming from the 7^th pay commission on the other side, it is difficult to predict when the next rate cut will take place. Therefore, you need to have a blend of fixed income strategies in your portfolio including hold to maturity, acrrual and dynamic products where managers have the flexibility to decide where it may be most appropraite to invest.

Your loans

RBI mentioned it will analyse the impact of the MCLR (Marginal Cost of funds based lending rate) and make changes to if required. Therefore, on the loan side nothing changes unless the MCLR rate moves further down, which is expected to be a gradual process.

Way Ahead

With Raghuram Rajan’s term ending on September 4, 2016, the appointment of a new RBI Governor and formation of Monetary Policy Committee(MPC) means that we should watch out for whether we see more of the same in the next bi monthly policy on October 4, 2016, or whether there will be a big change from the past.

Image Credit: www.gograph.co

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Rexit + Brexit & its impact your investment portfolio

Over the weekend there was news that RBI Governor Raghuram Rajan’s term is ending on 4th September 2016. The market clearly does not like surprises, and therefore the impact could be short term volatility in currency,equity  and bond markets. Thus, whilst this is clearly a short term impact to India’s image in the international community and financial investors, we believe there is a list of very eligible candidates who can be appointed. In fact, the events over the weekend are likely to get the government to move much faster on finding an approprite replacement, and thus we believer there is no need of changes in your investment portfolio as a result of this. Ultimately, we believe that institutions are typically bigger than their chief executive.

The event which is likely to have a much bigger impact is the probability of Britain moving out of the European Union.  Over the last couple of weeks, there has been significantly higher newsflow around Brexit and the importance of 23^rd and 24th June for world markets, due to the Brexit. Let’s understand the possible impacts of Brexit on your personal finances.

What is Brexit?

The European Union has 28 countries as its members. European policies currently aim to ensure free movement of people, goods, services and capital amongst its member states. Out of these, 19 members use Euro as its currency. Britain which is one of its members is evaluting whether it needs to stay in the EU or exit. That’s why it is termed as Brexit – ‘ Britain Exit’.

Bexit and your investments

There is a possibility of largely two scenarios in the referendum on the Brexit, that is,  either a leave or a stay. Let’s examine the impact of each of these on your investments separately. As indicated, this will be decided on the basis of a referendum which is going to be held on 23 June – a final decision will be taken on the basis of the votes.

Scenario 1– Leave

• Depreciating Pound and Euro / Strengthening Dollar and Yen– Thus, if you have kids studying in the UK or planning to study there, you couldend up paying lesser.

• Strengthening Dollar

The US dollar could then be expected to strengthen in the short term as investors will rush to Dollar as a safe investment vehicle. If you have any dollar denominated investments then those will increase in value.

• Sell off in the emerging markets

In the short term emerging markets including India , as well as UK and European markets, could experience volatility due to flight of capital to safety . However, the expectation is that impact on India will be lesser compared to the other emerging markets due to its realtively stronger fundamentals. Thus, if you have investments in emerging markets then those might see temporary fall in returns. Do not panic and sell. Over the longer term, the performance of your emerging market funds will depend on the economic scenarios of the individual countries to which your fund is exposed to, apart from the temporary brexit effect.

• Gold could become attractive

Gold is gaining importance as an  investment vehicle with rising global uncertainties. Therefore, Gold Exchange Traded funds, Gold funds and sovereign gold bonds could benefit from this price rise of gold, as well as strength of the US dollar.

Scenario 2- Stay

• Equity markets could react positively

This will ideally mean increase in the value of your equity investments since world markets could do well, as the overhang of the Brexit has led to signficant market volatility over the last few weeks. A relief rally could follow, especially as multiple other EU countries are also at this point looking to see what the UK does with the Brexit.

• Bond markets could be stable

If the brexit does not take place there may not be any selloff in the bond markets which means the yields could remain as is. The higher inflation ovehang on domestic bonds is likely to be the driver of bond prices going forward in that case.

• Euro/Pound sterling could strengthen

There will be increased confidence in European markets and Euro could appreciate. Your Euro denominated investments could do well in this case.

All in all,

Since the outcome is hard to call currently, one may need to track this event carefully, and decide you investment strategy carefully basis the outcome of the referendum. In the short term volatility may be expected to be higher than normal, but do not take panic calls and stick to your asset allocationand overall financial goals and plans.

 

 

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RBI maintains status quo

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.

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 7^th 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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“I told you so. Why weren’t you listening? ” RBI to bond markets

As the Indian Rupee continued to face downward pressure against the US dollar, the Reserve Bank of India, late on Monday, took the classical textbook response to a falling currency by indirectly raising interest rates, following in the footsteps of other emerging markets, including Brazil and Indonesia.

The bond markets were surprised and saw a big sell off on Tuesday as a result. But should they really have been? RBI, over multiple conversations for many months now, has been talking to bond market participants and explaining that whilst falling inflation is good news and gives them some leverage to bring down interest rates to boost slowing growth, there is also a significant focus that they have on the external environment considering the high current account deficits that India runs and the possible tapering of Quantitative Easing by the Fed, which needs to be kept in mind as well. Unfortunately, most bond market participants were not listening, or listening to only what they wanted and liked to listen to.

Essentially, the RBI has been trying multiple things to stabilize the depreciating rupee with limited success thus far. A falling rupee is not good news for India due to the inflation risks that it poses, and high current account deficit as well as India’s dependency on foreign capital flows. Thus, as a part of its rupee management process, the RBI brought in three steps to reduce liquidity, and thereby speculative activity on the rupee:

1. Increased interest rates on Marginal Standing Facility ( MSF) by 2% to 10.25% – This is the penalty rate at which banks can borrow over repo rate.
2. Announced sale of Rs 12000 crores of G Secs under Open Market Operations (OMO) – ie it will sell securities to market and mop up liquidity
3. Capped liquidity under Liquidity Adjustment Factor ( LAF) at 1% of Net Demand and Time Liabilities ( NTDL). This means bank borrowings above Rs 75000 crores will be at 10.25%.

The good news is that these steps have brought in, through a manner that they can be changed overnight, just like they were introduced, unlike a classical interest rate hike that can take much longer to reverse. Thus, RBI could pull these steps back very easily, if the rupee stabilizes.

Whilst the bond markets adjust to this, there is likely to be a negative impact on a mark to market basis that investors will see on their bond portfolios, whether held through short term bonds or long term bonds or even liquid/liquid plus funds.

We believe that as bond markets digest this news over the next few days and weeks, there is an opportunity for long term investors to buy into this weakness from a medium to long term perspective. Short term bond funds, fixed maturity plans and dynamic bond funds are good options for investors to look at in this environment, considering their tax efficiency if held over one year.

The next time your spouse nags you about something continuously, please listen. You don’t want her to tell you – I told you so!

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RBI hikes interest rates – what to do now?

Diversify portfolio to maximize your gains

The Reserve Bank of India (RBI) surprised the financial markets earlier this week by raising repo rates by 0.5 per cent against the broadly expected rate increase of 0.25 per cent.  This was driven by significant concerns on inflation and a willingness to compromise on growth, even as inflation continues to be on the upside. This was very different from the view expressed by the chairman of the US Federal Reserve last week wherein he indicated that any increase in inflation are unlikely to be sustained and are temporary in nature. The US Fed therefore decided to focus on growth rather than worry about inflation. Even as the financial markets get more integrated, the actions by the two very powerful central banks could not have been more different. With such conflicting signals emerging from different directions, what should investors do in this environment?

■ Stick to your asset allocation:

There is a wealth of empirical data available indicating that long term portfolio returns are driven largely by asset allocation decisions rather than market timing and security selection. Unfortunately, most investors tend to give undue importance to market timing and the choice of security, rather than the asset class selection itself.  For example, investors tend to spend a disproportionate time deciding on which mutual funds/stocks to buy, and what level of the Sensex to buy or sell at, rather than the decision on how much money from the portfolio should be allocated to equities itself. If you are unable to do so yourself, please take the help of a financial planner. Once the decision on asset allocation has been taken, it is critical to stick to it and rebalance on a predefined basis, irrespective of shorter term financial market movements.

■ Prepay your loans:

With the RBI continuing to hike rates, banks are likely to raise interest rates on both their loans and deposits, though the quantum of increases on loans is likely to be higher. It is therefore important to measure the post tax returns on your fixed income investments against the overall cost of your loans, and take a decision on prepayment accordingly. A large number of investors tend to rush to park monies in deposits when rates go up, and continue to pay out high interest rates on their loans at the same time. This is especially important as most loans have been on floating rates for the last couple of years.

■ Diversify your portfolio globally:

Whilst investing in domestic financial markets are preferred by all investors, differing actions by central banks could cause differing returns at different points. For example, there has been a wide variance in returns between US stock markets and Indian stock markets over the last year. It is therefore important to allocate between 10-20 per cent of the portfolios to international markets as well.

This article was written by Vishal Dhawan, CFP^CM and appeared in the Asian Age  on 7^th  May 2011 .

 

 

 

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