Equity investors should stay invested or make fresh investments in the markets with a minimum holding period of three years while fixed income investors should look to take advantage of expected fall in interest rates by investing directly in government and corporate bonds or by investing in bond funds for a period of 36 months and longer.
Dr. Raghuram Rajan, the RBI Governor explicitly stated post policy review on 5th August 2014 that while the macros were improving in the economy, much work still needs to be done for the economy to make a strong foundation for future growth. Dr. Rajan is in for the long haul and is willing to put aside short term considerations for long term benefits.
Dr. Rajan’s policy is just what is required for equity and fixed income investors as there will be benefits of growth with lower inflation expectations over a period of time. The markets did not take the policy too well, looking at it as hawkish rather than dovish. Sensex and Nifty are down post policy giving up earlier gains while yields on ten year government bond, the 8.40% 2024 bond is up 8bps.
The INR is up against the USD but it should be seen in the context of the fact that the INR has fallen by around 1.5% over the last couple of weeks on global issues of Argentina debt default and Middle East tensions.
RBI cut the SLR (Statutory Liquidity Ratio) of banks by 50bps in its policy review on 5th of August 2014. Apart from this there was no change in policy rates on Repo and CRR (Cash Reserve Ratio) that were maintained at 8% and 4% respectively.
The markets were expecting some indications from the RBI on rate cuts going forward as CPI (Consumer Price Index) inflation had fallen to levels of 7.31% in July, which is a multi year low. RBI did not provide any comfort to the market on repo rate cuts even though the policy stated that it was satisfied with the way inflation was trending down. RBI target for inflation is 8% and 6% for January 2015 and 2016 respectively.
Markets may have been disappointed that Dr. Rajan, while appreciating the fact that inflation is coming off, indicated that until inflation is well on it way down towards 6%, he will not be in a hurry to easy monetary policy.
Markets are many times short sighted as positions are built on unreasonable expectations, in this case a highly dovish policy statement that did not come about and hence the negative reaction to the policy.
The SLR cut is by itself positive as it signals that the RBI is confident of the government’s commitment to fiscal consolidation with Budget 2014 drawing a fiscal roadmap of 4.1%, 3.6% and 3% deficit over this fiscal and the next two fiscal years respectively.
Looking forward over a two to three year period, the horizon appears bright with fiscal deficit down, inflation down and economic growth picking up. RBI has maintained its forecast GDP growth of around 5.5% for this year as growth indicators of IIP (Index of Industrial Production) and exports are up. IIP growth for the first two months of this fiscal is at 4% against negative growth of 0.5% seen last year. Exports are up by around 9% in the first quarter of this fiscal against a negative 1.5% growth seen last year.
India’s foreign exchange reserves are at record highs of USD 320 billion from levels of USD 280 billion seen a year ago. The INR has appreciated by 11% since August 2013 when it touched record lows of Rs 68.80. India’s current account deficit is down from levels of 4.7% of GDP to 1.7% of GDP in fiscal 2013-14. Capital flows are robust with FIIs investing USD 16 billion in equities and debt fiscal year to date.
India is definitely on a better wicket than what it was last year, when macro indicators from fiscal deficit to inflation to current account deficit were highly negative driving down the INR to record lows on worries of Fed tapering of asset purchases. The Fed has lowered its asset purchases from USD 85 billion a month to USD 25 billion a month since December 2013 and will end purchases by October 2014. The INR is looking strong despite Fed taper and this is largely due to improving macros.