Not the beginning of lower interest rate cycle yet! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Not the beginning of lower interest rate cycle yet! 

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In this issue:
» Has Sensex zoomed past valuations?
» Too soon to be euphoric about positive macro data
» Has Chinese economy bottomed out?
» India slips further on FDI Confidence index!
» ...and more!


00:00
 
Post election results, one event that markets had been waiting for was Dr Rajan's decision on policy rates. Speculations have been rife how tough it will be for Dr Rajan, with his focus on inflation, to work in Modi's regime. With all these talks, RBI's inflation focused policies are being projected as a roadblock in the way of growth. This is despite enough evidences on how unstable but growing economies have ended up in a crash.

In today's monetary policy review, its first under the Modi Government, the RBI has maintained status quo on repo rates. Meanwhile, it has cut the statutory liquidity ratio (SLR) by 0.5%. In keeping repo rates unchanged, RBI has stuck to its role of maintaining currency stability. As far as India Inc is concerned, around 70% of the total debt of BSE 500 companies (non banking and non finance) belongs to net importers. Even as India Inc. expects better times ahead, any slip on currency aspect may lead to margin erosion. And that in turn may impact the credit profile or result in rating downgrade for some firms. At the same time, a cut in SLR is likely to ease up credit flow to private sector, so that it can make the most of growth measures likely to be taken by the new Government.

Coming back to growth- inflation dilemma, now that Mr. Rajan and Modi are to work with each other, it is time to shed some myths. It is not because of RBI's stance on interest rates that growth has taken a set back. As an article in Business Standard suggests, for an economy like India, inflation issue is rooted in supply side gaps. The role of RBI is to maintain the currency stability. In maintaining interest rates, it is not constraining the economic growth, but merely responding to the years of mess in the economy.

The solution to current economic problem lies not in easing interest rates. For a stable recovery, India needs to address supply side loopholes that can also lower inflation. And that is something under Government's control. Some of these measures include removing logistic bottlenecks. Food wastage in India is a case in point. The economy is bearing double costs, first due to food wastage and then on account of food subsidies. Not to mention the food inflation, the prime inflation driver. Similarly, huge subsidies on fuel sold by state run oil companies have restricted private sector participation. Perhaps by introducing rational taxation for fuels, the Government can move on to controlling subsidy expenses. That will create a level playing field for public and private firms in the energy sector, ensuring better supplies and lesser costs for the fuel.

We do believe that urgent supply side reforms are necessary for the RBI to act decisively on interest rates. However, we would like to reiterate that the RBI, given its conservative stance, is unlikely to be in a hurry to cut rates. Which in turn means that investors and corporate looking forward to the lower interest rate cycle will have to be patient. Until and unless the new government can reasonably assure the central bank of its actions to keep prices rise under control, the governor may not relent. And hence it will be too risky to speculate on whether we are on the cusp of reversal in interest rate cycle.

What do you think of the recent monetary policy decision by RBI? Let us know in the Equitymaster Club or share your comments below.

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01:36  Chart of the day
 
The BSE-Sensex is touching record highs as the bulls have been on a non-stop rampage since quite some time. But the key question is: Whether the Sensex has zoomed past fundamentals too? Let us take a look at some of the facts. The Sensex valuation, which is hovering at TTM PE of 18 times, is very close to the 10 year average. However, weak corporate earnings in FY14 do not justify such level of valuations. This suggests that anticipation for improved growth in FY15 on the back of economic reforms is also built in. The potential for further gains seems limited, purely on the basis of fundamentals. So should one stay away from markets completely? Certainly not! But we do recommend investors to be extremely cautious in investing in the markets at these valuation levels. It is to be noted that many stocks in sectors such as Realty, Power and Capital Goods which are dependent on economic reforms have reached peak valuations. However, these are the very sectors where fundamentals are yet to catch up with valuations. On the other hand, defensive sectors such as Healthcare, FMCG and IT are still in the adequate valuation range and provide cushion of safety. The best method is to stick to the fundamentals and be stock specific while investing irrespective of whether the stock belongs to defensive or cyclical sectors.

Expectations built up, will delivery happen?
*Since September 2004
#Since May 2008


02:15
 
The recent official data released for the new financial year paints a buoyant picture of the core industrial sector. The core sector index that includes steel, natural gas, refinery, electricity, cement, fertilizers and crude oil was reportedly up 4.2% in April 2014 from a year ago. This implies the power shortages faced by the industry could be lessening. It also implies that the demand for steel remains quite steady. Cement production also looks high, tweaking the index higher. But much of this growth is on account of low base-effect. The core sector makes up nearly 38% of the index of industrial production (IIP). The industrial performance is largely driven by the manufacturing sector. And that continues to remain sluggish. Weak consumer demand and fragile investment sentiment continues to dampen the uptick in manufacturing sector. Moreover, lack of effective labor law implementation is hampering the manufacturing growth. Therefore, the ground reality is yet to change. And the positive official data can be illusory. Thus, only a genuine pick-up in demand backed by expeditious project clearances and right policy framework would turn out to be a catalyst to industrial growth. Investor should watch out for the same while taking investing decisions and not get carried away by short term developments.

02:45
 
There are speculations that the Chinese economy has bottomed out. Also that new policy measures will help the economy recover to its erstwhile double digit growth rate sooner. The Chinese government recently announced fresh supportive measures, including cut in reserve requirements for commercial banks. In addition it will offer re-lending and bond financing for small firms. However, the official factory output data in China does not yet support the claims. The biggest risk to the Chinese economy continues to remain from the real estate sector. A possible realty bubble burst could have a spillover effect on other sectors as well. Moreover the big fiscal stimuli that came from the government earlier are now largely ruled out. Instead the government has its focus on reforms to try to put the economy on a more sustainable footing. Whether the Chinese government will be able to turn around the economy sooner than the Modi-led government in India? Well, that is anybody's guess. However, what remains certain is that economic hiccups not just in India but globally, are far from over. Therefore investors buying into the 'worst is over' argument can do so at their own risk!

03:29
 
We've been hearing about how India's GDP sunk to a decade low in the fiscal gone by. However, that's not the only multi-year low embarrassment we will have to face. Firstbiz.com reports how we've performed poorly even on the FDI confidence index. Here, India has suffered a two place drop from 5th to 7th, its lowest rank since 2001. However, just as we may have seen bottom on the GDP growth front, we may have bottomed out even on the FDI confidence front. One of the major reasons to feel so is the arrival of the new Government at the centre. Unlike its predecessor, this Government has a reputation for being more business friendly. And to give credit where due, it seems to have made all the right noises so far. What more, even the stock market indices are on a tear on account of precisely these positive sentiments. We just hope that the sentiments now translate into real policy actions.

04:10
 
Gold investors are a concerned lot these days. The price of the yellow metal has been in a down trend recently. In the month of May, the gold price fell by about 10%. The main reason for this correction was the Reserve Bank of India's (RBI) decision to ease gold import norms. However, there is more negative news in store. Keeping in mind the fall in global gold prices too, the Indian government has cut the import tariff value on gold from US$ 424 per 10 grams to US$ 408 per 10 grams. The import tariff value is the base price at which the customs duty on gold is calculated to prevent under-invoicing. Thus expectations are high that the new government will cut the import duty on gold in the upcoming budget. These measures would certainly result in more gold imports into the country.

Also, the months from June to September have traditionally witnessed weak demand for gold. All these factors have led many market participants to conclude that the price could fall another 5-10% over the next one to two months. Should these factors affect investors' allocation to Gold'? We don't think so. Gold should form 10-15% of an investor's portfolio as it is an effective portfolio diversifier and acts as a good hedge against inflation. Gold is a good long term investment and investors should not speculate on the price based on short term factors.

04:40
 
In the meanwhile, the Indian stock markets have been trading firm. At the time of writing, the benchmark BSE-Sensex was up by 174 points (+0.7%). Majority of the sectoral indices were trading strong led by metal and realty. FMCG and pharma stocks were among the few stocks trading negative. Majority of the Asian Indices were trading in the green with Hong Kong and Japan being the biggest gainers. However the Chinese market is trading weak. The European markets have opened the day on a weak note.

04:56  Today's investing mantra
Time is on your side when you own shares of superior companies." - Peter Lynch
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2 Responses to "Not the beginning of lower interest rate cycle yet!"

Venkatesan Ganesan

Jun 4, 2014

Over the last 3 months or so just the feel good factor and the perceived abilities of Modi that has kept the India inc. above the firm ground. Although positive sentiments are a must to feed into further growth and so on, Modi's government has to demonstrate through strong and much needed policy measures and an integrated governance framework to deliver us on the feel good factor. We are a couple of weeks before the monsoon show and this government's first budget. Till then, Rajan's policy of wait and watch is the best antidote. Let us not put too much pressure on Rajan during every quarterly monetary policy reviews. We all know that we are running a marathon and not a 100m race.

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Harjeet Singh Kalra

Jun 3, 2014

I agree. Supply side constraints need to removed asap. We have to abolish the laws which curb the farmers freedom to sell his produce. We have to minimise wastage of food & vegetables to improve supply of fruits &vegetables (establish food chains & food processing units in villages)

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