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Investment Insights

Suyash Choudhary

The RBI Intervenes Again

By: Punam Sharma

RBI Governor Rajan hosted a media briefing today. The explicit objective seemed to be to calm market fears with respect to two points: One, the future of rupee once oil marketing companies (OMC) dollar demand is back into the market. Two, concern on RBI policy rates. We summarize takeaways from these below:
 
1. External account and the rupee: Rajan expressed satisfaction with the compression in trade deficit so far and gave an explicit estimate for the current year’s current account deficit at USD 56 billion. This is USD 32 billion lesser than last year. Additionally the RBI has already raised USD 18 billion via the recent initiatives under FCNR and banking capital. This, then, represents a USD 50 billion swing from last year. Given this context if FII flows, which were positive USD 26 billion last year, are negative this year of an equivalent magnitude even then the flow picture breaks even. Debt FII exposure in India is already down from USD 37 billion on May 21 to USD 19 billion today. The governor judged that most of what is left could be ‘more patient money’ but even if it were to leave, given its reduced size, it will not present a huge risk.
 
The other market worry is with respect to what happens to the rupee when OMC dollar demand is fully back in the market. As we have suspected for some time, the RBI has quietly let a large part of the demand already re-enter the market over the past few days without most of the market getting wind of it. The rest can be done in a phased manner. Finally, there are concerns about what will happen to the rupee when the OMCs are called upon to repay dollars that the RBI has been providing them directly so far. This is due between February and April of 2014. Again, the governor seems quite comfortable with how this can get managed. If the exchange market is calm by then they can buy from the interbank market and repay the RBI. If not, then the swaps can be rolled over for a more opportune time. Finally, the RBI can even ask for payment in rupees instead of dollars if the market continues to be weak. All in all then, the governor presented a largely sanguine picture of the external account and quite in line with a view that monetary policy can revert to looking at domestic growth versus inflation trade-offs. This will also involve the RBI restoring overnight rate anchor to the repo rate at some point in the near future.
 
2. Domestic market and RBI’s policy rate expectations: The governor was quite emphatic in addressing market concerns on the future direction of RBI policy rates despite much clarification provided in the recently concluded monetary policy review. These concerns had become more pronounced after the October CPI release yesterday (the print was higher than market expectations at 10.09%, largely on account of still rising fruits and vegetable prices). Rajan interpreted the CPI print as well saying that food inflation, though worryingly high, is still to see the effect of harvest. Furthermore, core CPI has fallen from 8.5% to 8.1% with a decline in momentum as well. Most importantly, he explicitly acknowledged market worries on future policy rates given such data. In this context he reiterated that RBI is concerned about the weak economy as well as high inflation. Furthermore, he emphasized RBI’s belief that the weak economy, increases in food supply, and recent policy rate hikes will provide a disinflationary impetus and that recent data had not dispelled this view. The RBI will watch the incoming data carefully, especially looking for the effects of the harvest on food prices as well as the second round effects of fuel price increases and exchange rate depreciation, before making further decisions on interest rates.
 
Finally, Rajan announced an OMO for next week for INR 8,000 crores quoting liquidity tightness as reflected in market interest rates.
 

Takeaways
 
• The analysis and conclusions presented by Rajan today are quite consistent with those in the policy just gone by and with what we have understood as the new RBI’s monetary policy framework (please refer our note “Objects in the rear view mirror: View ahead for bonds”, dated 7th November for details). As we had mentioned there, the policy stance is better summarized as ‘this tight for longer’ rather than ‘continue to tighten’. If anything, the governor has reiterated this in his statement today. He also continues to show some amount of patience for the disinflationary forces mentioned to reflect in inflation. Our own analysis (detailed in the previous note) suggests recent inflationary impulses are likely to be temporary. The benign effects on headline CPI from fading out of these impulses may start getting seen as soon as the next print itself. If this proves to be true, then repo rate could have topped out at the current level of 7.75%. At worse, we will look for one more hike to 8% if inflation for some reason proves to be more stubborn than is currently anticipated. More importantly, as the central bank gets fully comfortable with the volatility in the rupee it will steadily ensure that the overnight rate sets closer to the repo rate. Hence, even accounting for one more rate hike, directionally overnight rate setting will only head lower over the next few months. As the market gets more convinced of this, the current term spreads will look too attractive to ignore for most investors.
 
• The other near term worry for the market has been the heavy supply of INR 75,000 crores in November. However, as explained in our recent note, we expect this pressure point to also fade out between December and March. Given our liquidity calculations and our understanding so far of RBI’s liquidity framework, we were looking for at least INR 50,000 crores of OMOs between December and March. The first of these for INR 8,000 crores has been announced sooner than expected.
 
In summary, a gradual shift down in overnight cost of funds and easing of supply concerns from December should bode well for bond performance in the months ahead.
 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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admin

Even as the Sensex retouched the 21,000 mark recently in October 2013 that it last hit in January 2008, there is no getting away from the fact that a large number of investors have lost a lot of money during this five-year period.
 
While a lot of investors we meet have lost money because they made bad investments at the height of the bull market, there is one more factor that has caused people much anguish.
 
In hindsight, a large number of investors regret that they had invested a huge amount of money at one go during the 2007-08 period.
 
“All the money I invested in January 2008 is now in the drain,” is a common regret we hear. Or there’s something like – “Only if I had not invested so much at one time in October 2007!”
 
Another common refrain we hear is – “I had put a few lac rupees in some mutual funds in early 2008 when the markets were doing well, but all my funds are negative now!”
 
SIP and Invest
 
We believe investing a large chunk of your money at one time adds a great risk to your portfolio.
 
While we would not like you to time the stock markets, as we believe it is an impossible task to find that perfect time to invest, a great way you can reduce risks from your stock market investments is by way of a concept called “rupee cost averaging”.
 
This you can do via what mutual funds call a ‘Systematic Investment Plan’ or SIP. Here, you invest in a systematic, disciplined manner at specific time intervals – a specified amount of money is deducted from your bank account and invested in the mutual fund(s) of your choice.
 
Now, the question is – How is SIP better than a one-time investment into the same fund.
 
Well, here are some calculations to show the difference.
 
The following table shows the one-year investment record of two investors. Let’s call them A and B.
 
While A invests Rs 1,000 per month for 12 months (so he invests a total sum of Rs 12,000 over 12 months), B makes a one-time investment of Rs 12,000 in January.
 

  Investor A Investor B
Month NAV/Cost per unit (Rs) SIP Investment (Rs) Units bought NAV/Cost per unit (Rs) One-time Investment (Rs) Units bought
Jan-12 9.3 1,000 107.0 9.3 12,000 1,284.1
Feb-12 9.4 1,000 106.4
Mar-12 8.1 1,000 123.1
Apr-12 8.8 1,000 114.3
May-12 8.0 1,000 124.8
Jun-12 8.9 1,000 112.0
Jul-12 9.1 1,000 109.9
Aug-12 8.3 1,000 120.3
Sep-12 7.6 1,000 132.1
Oct-12 6.5 1,000 154.8
Nov-12 6.9 1,000 144.3
Dec-12 7.6 1,000 131.6
Total 8.1 12,000 1,480.6 9.3 12,000 1,284.1

 
Note: The NAVs are assumed figures;
 
Units bought = Investment amount ‘divided by’ NAV per unit
 
As you can see in the above table, Investor A invests every month at different levels of the mutual fund NAV (this is due to the different levels of stock markets each month). He thus buys more units when prices (NAV) are low and less units when prices are high.
 
Now, as you can see from the last row of the table, at the end of 12 months, Investor A has more number of units with him for the same Rs 12,000 he invested like Investor B.
 
What is more, the average cost for Investor A is lower at Rs 8.1 per unit, as compared to Rs 9.3 per unit for Investor B.
 
Now the important thing to look here is not that A has more units than B at the end of the one-year period, but that A did this without parting away with all his savings at one time and without worrying about timing the market.
 
All he did was use the simple yet amazing power of SIPs to regularly invest in the mutual fund of his choice, and ended up with a better return that what Investor B earned with his one-time investment.
 
It’s More than Just Returns
 
While a better long term return is the outcome of following the SIP method of investing, the key is that it infuses discipline and patience in you, which are very important attributes of successful investors.
 
Also, this takes away the stress of keeping track of where the stock market is heading, as you invest irrespective of what the market is doing.
 
In all, the idea must be to keep SIP-ping so that not only you benefit from the power of patience and discipline in investing, but also compound your money over the long run.
 
That, after all, is the ultimate aim of being an investor.
 
What do you say?

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Suyash Choudhary

After what turned out to be a somewhat dovish RBI policy, bond yields have been rising again over the past few sessions. We assess below the broad macro-economic environment as it stands today and in that context assess the view over the next 3 – 4 months. This is done in context of the following parameters:
 
1. Growth: Notwithstanding some ‘green-shoots’ being witnessed recently, the overall growth environment remains undeniably weak. While there may be some sequential pick-up in second half of the financial year largely owing to better agricultural output, the momentum on services sector remains weak and job losses continue in the organized services. Additionally, government will have to compress spending in the months ahead in order to contain fiscal deficit just as it had to last year. Furthermore, the relatively tight interest rate conditions has stalled banks from cutting lending rates; which they were beginning to do on the finance minister’s moral suasion early July. Quite the reverse, banks have started hiking rates again right in the middle of the so called ‘busy’ season on credit. Given these headwinds, any sequential momentum on growth is likely to be modest.
 
2. Inflation: Inflation has resurfaced as a potential policy head-ache lately. A large contributor to the recent episode of inflation is prices of fruits and vegetables (please refer our note “Of inflation, expectations, and targeting” dated 15th October for details). Additionally, there is a continuing effect of recent rupee depreciation that is also getting seen in prices. However, if one were to take a forward looking view, it is likely that fruits and vegetables prices stabilize with the effect of recent supply disruptions fading out. Additionally, kharif harvest is likely to be robust and rabi sowing has got on to a great start. These are likely to impart a further stabilizing effect to overall primary articles’ inflation. Hence, barring the next one or two inflation prints, it is reasonable to expect that the momentum on inflation will fall towards the fiscal year end.
 
3. Fiscal deficit: Fiscal deficit continues to be a major risk. The government has notched up 76% of the full year’s target by September (versus 69% of provisional fiscal deficit even last year). However, the finance minister only recently has reiterated that the fiscal deficit target is a red line that will not get crossed and that he has the prime minister’s support in this endeavor. While in all likelihood the target will again get achieved only through cutting productive expenditure and rolling over contracted payment obligations, there is little to doubt yet that the finance minister is very serious about this target.
 
4. Current account deficit: When talk of Fed taper first surfaced in May, India was looking extremely vulnerable on the current account. However, trade deficit has improved sharply since then on import slowdown (government measures on gold combined with effect of slowdown) as well as pick up in exports. All told, current account deficit for the current year is now pegged at around USD 60 billion; a staggeringly large compression from the previous year. Furthermore, policy effort in encouraging FCNR flows and banking capital have paid off with the 2 measures having netted USD 15 billion already. Hence, even if taper talk were to resurface, India’s reliance on foreign portfolio flows has lessened considerably at least in the current year. In line with this development, the thrust of monetary policy is shifting back from managing external risks to the traditional growth versus inflation trade-off.
 
Based on the above assessment, the following conclusions can be made with respect to our macro-economic environment:
 
• The outlier macro-economic risk in the form of current account vulnerability has subsided for India, at least for the current financial year. This has ensured that volatility in financial markets (including in currency and bonds) has progressively subsided over the past month or so.
 
• Over the very near term inflation is a problem and has captured bond markets’ attention. However, the prognosis over the next few months is for momentum to decline as primary articles’ prices stabilize and currency depreciation pass through is completed.
 
With this context in mind, we focus on the bond market’s immediate two problems:
 
RBI’s monetary policy framework: Market has been somewhat anxious since Rajan’s entry as the new RBI governor, given his apparent focus on inflation. This has led some analysts to fear a series of rate hikes given the recent stubbornness of inflation. We have disagreed with that assessment (please refer our note “Of inflation, expectations, and targeting” dated 15th October for details) and have been happy to note our thinking getting broadly ratified in the latest RBI policy review. The central bank wants to anchor policy to inflation but this doesn’t mean that it will target the spot level of inflation at whatever cost to growth. Time and again Rajan has emphasized that he will fight inflation keeping the weak growth environment in mind. In post policy calls he has even flagged the risk of over-tightening policy given the lag with which rate hikes affect economic activity. Furthermore, while he is cognizant of offering a positive ‘real’ interest rate to savers (an argument used often by those advocating a series of rate hikes) he has on various occasions emphasized that the needs of producers (who are facing quite high real rates owing to lower producer price inflation) have to be balanced with that of savers (who are still facing a disincentive to save owing partly to lower real rates). Obviously, if for some reason inflation momentum doesn’t turn then the RBI can resort to hiking rates again. However, given what we know of its current framework, we think that it will give time to the disinflationary forces that it has identified (output gap and better harvest) to show themselves in inflation momentum. Thus in our view the RBI’s current stance can best be summarized as ‘remain this tight for longer’ rather than ‘continue to tighten’. Given this, and assuming an inflation trajectory consistent with what we and indeed the RBI currently estimate, we believe that repo rate may have peaked here or at worst will peak 25 bps higher at 8%. More importantly, as the central bank gets fully comfortable with the volatility in the rupee it will steadily ensure that the overnight rate sets closer to the repo rate. Hence, even accounting for one more rate hike, directionally overnight rate setting will only head lower over the next few months.
 
Bond supply: The other near term concern for the market is the heavy bond supply over the current month. Indeed, supply over November is the highest for the year at a net of INR 75,000 crores. Furthermore, market is as yet uncertain as to when and how much of bond purchases the RBI will do under the new leadership. In our view, while there are important differences in the RBI’s liquidity framework under the new governor, it is not drastically different from the old. To recap, under Subbarao the RBI had a loose commitment to contain liquidity around 1% of net demand and time liabilities (NDTL) of banks. Under the new regime limited liquidity is provided at 3 windows to the extent of 0.5% NDTL each before the penalty rate of MSF is hit. These are the repo, export refinance, and term repo windows. At this juncture, while the currency market is still in the process of getting normalized, the RBI is happy for the overnight anchor rate not to be the repo rate. However, as per the governor’s own commitment, once the currency market is fully normalized (with oil marketing companies meeting their full requirement from the interbank dollar market), the overnight rate will be moved closer to the repo rate. In order to do so, the RBI will have to move liquidity to between 1 – 1.5% of NDTL of banks (so that term repo rate is fixed closer to repo than the MSF rate). Even if this is achieved by relaxing borrowing caps under the various windows, it is reasonable to assume that the central bank will want to inject permanent liquidity via OMOs beyond a certain threshold. For the purpose of analysis here, we conservatively assume this threshold to be 1.5% of NDTL (approximately INR 1,15,000 crores). Looking at the liquidity scenario, the deficit as at 1st November is approximately INR 1, 00,000 crores corresponding with the government’s surplus with the RBI is at close to zero. Going forward, there will be two sources of liquidity leakage: one, the system will see approximately INR 60,000 crores of further leakage owing to rise in currency with public between now and March. Two, as the government starts cutting expenditure to attain its fiscal deficit targets its surplus with RBI will increase, much in line with what happened over second half of last year. Conservatively speaking, this can lead to another INR 50,000 – 75,000 crores drain from the system since the government’s surplus with the RBI is not available as liquidity to the banking system. All told, on its own system liquidity can well deteriorate by more than INR 1, 00,000 crores further to a total of more than 2.5% NDTL absent RBI’s intervention. Because of this, we estimate that OMOs of at least INR 50,000 crores may be required between December and March in order to keep liquidity deficits under reasonable control. This is against INR 73,000 crores done during the same period last year. After November, the net supply of government bonds is INR 95,000 crores. Adjusted for even a conservative estimate on OMOs, the net supply will be only INR 45,000 crores. Hence, bond supply worries that are currently plaguing the market are likely to disappear once we move into December.
 
 
Conclusions:
 
Market participants are very perturbed about near term inflation, the RBI’s reaction to the same, and bond supply over the current month. However, as our analysis above shows, these are likely to be very temporary triggers and do not justify the term premium currently in the yield curve with a medium term perspective. While admittedly the volatility over the past few sessions has been much more than we had anticipated coming out of what proved to be a relatively dovish RBI policy, nevertheless our medium term view remains in line with the analysis presented above,. Hence, we continue to run our bond and gilt funds fully invested with a preference for government bonds (given better supply demand dynamics on that curve till March). While this means more volatility in the near term, if our view is correct pay-offs are likely to be quite handsome over the next few months. For investors not desiring this level of volatility, intermediate duration products (like for instance medium term funds) may be a better option.
 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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