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Investment Insights

Suyash Choudhary

A lot of India’s macro-economic ills over the past 4 years can be attributed to pro-cyclical fiscal and monetary policies. Our recovery from 2008’s global financial crisis was quite sharp since domestic drivers had remained broadly intact and had resurfaced strongly as the external shock abated. However, both monetary and fiscal policies remained pro-cyclically ultra-loose much beyond when recovery had taken hold. This is known better with the benefit of hindsight while then presumably policy makers were reluctant to reduce the stimulus in case the economy slid into another spiral. The point is evident in the graph below which shows a V-shaped recovery in industrial production (IIP) even as fiscal spending continued at an elevated pace and overnight rate hikes followed a ‘baby-step’ approach even from emergency low levels that they were cut to in response to the 2008 crisis.
 

 
Source: CEIC and Internal research
 
While these policies facilitated a demand revival, unfortunately supply responses continued to deteriorate in the face of myriad issues including those of government policy and confidence. It is widely acknowledged now that had monetary and fiscal policies been counter-cyclical then (that is, tighter in the face of strong demand revival and weak supply responses), India would possible not be faced with the current degree of its entrenched trilemma of high inflation, high credit to deposit ratio, and high external imbalance; all in the face of very weak growth.
 
The Case Today
 
Market, researchers, and economic entities have reacted in various ways to the recent surprise pause from RBI in its December policy. While there has been visible relief from some quarters, some others have followed surprise with admonishment on the central bank’s reluctance even in the face of 11% plus CPI inflation. Arguments in favor of decisive rate hikes range from entrenched inflation causing second round effects, to high inflationary expectations of households, to the urgent need to provide positive ‘real rates’ to savers. All these arguments are very important and hold merit; just as they did 6 – 7 months back when some of the same community were gleefully egging RBI on to cut rates and restore positive liquidity. However, underneath this all, a question needs answering: How pro-cyclical can policy afford to be? Given the learning from post the 2008 episode, the importance of this question cannot be understated.
 
The graphs below show the current economic slowdown in terms of high frequency indicators. The one on the left tracks auto sales, industrial production, and non-oil and non-gold imports. All show a continued weak trend. Non-oil and non-gold imports have shown a negative growth most of this financial year with the weakness picking up pace in recent months. This partly explains why trade deficit numbers have continued to be benign despite export growth losing some momentum recently. Auto sales picked up some pace into festive season only to lose most of it subsequently. The graph on the right tracks credit and deposit growth rates. The fall-off in credit growth rate is noticeable lately and is largely explained by the unwinding of temporary lines drawn by institutions post the spike in money market rates from mid-July. Indeed, recent media reports tracking home loan rate cuts by leading banks suggest almost a complete absence of large ticket off-take. The sharp deposit growth in the chart is flattered by the massive pick up under FCNR. However, the net effect is still deposit growth outpacing credit growth after a long hiatus.
 

 

 
Source: CEIC and Internal research
 
While the context of weak growth is quite evident, the graph below charts some of the internal dynamics of inflation. Thus while the volatile vegetable inflation has galloped to 60% with most the spike happening over the last 3 months, CPI excluding fruits and vegetables has been declining steadily for most of this financial year. Within this, core CPI has also been quite stable lately and has in fact fallen over past 3 months even as the headline has spiked. Now that vegetable prices seem to be falling finally, the prognosis for headline CPI going ahead has turned as well. Thus, along with most in the market, media reports quote Rangarjan, a top policy advisor, estimating drastic falls in the next readings for both WPI and CPI.
 

 
Source: CEIC and Internal research
 
Conclusions
 
We have summarized above the experience with pro-cyclical monetary and fiscal policies (looser policy in face of stronger growth) pursued in the first phase post the 2008 crisis. These encouraged the building of persistent macro-economic imbalances the effect of which has finally been brought home to us this year. On hind-sight, there was scope for more emphatic counter-cyclical action (earlier tightening) which may have alleviated some of the pain being faced today. An obvious outcome of this phase was tighter policy for longer, notwithstanding the aggressive easing bandwagon that many analysts and observers had hitched themselves to earlier in this financial year. Now the chorus is in the other direction; to rectify all our built up imbalances over short period monetary remedies which again by definition will be pro-cyclical (tighter policy in the face of very weak growth). We have no dispute with the logic that India’s macro-economic imbalances are substantial and need to be corrected sooner rather than later if we are to have sustained growth and avoid future economic accidents. For this we do need higher rates for longer; again one of our pet themes (refer our note “Can aggressive monetary easing create a funding problem in India?” dated 29th May 2013 for details). However, what also needs to be recognized is that any incremental tightening now is being done pro-cyclically when underlying growth impulses are weak. In fact, with the government set to sharply curb fiscal spending over the next few months, impulses on the services sector may get weaker still. This by definition limits the overall room available for tightening or, put another way, sets the bar for further tightening fairly high. It is heartening to see RBI Governor Rajan displaying a healthy respect for this fact, even as he remains vigilant on future risks to inflation. Obviously, if inflation doesn’t fall as anticipated, he will be forced to respond and thereby accept an even more sub-optimal trade-off and settle for weaker growth still. However, given the limited room for pro-cyclical policies, it is prudent to wait to be sure. Also, if the anticipated softening of prices indeed materializes, the Governor would have added to instead of deleting from the RBI’s store of credibility.
 
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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Suyash Choudhary

The RBI kept all rates on hold against market consensus of a 25 bps hike. In fact there were sections of the market fearing a 50 bps hike as well. The accompanying commentary by no means takes the focus away from inflation. However, it takes a wait and watch approach terming the decision a ‘close one’ given the disinflationary forces still at work and it’s assessment that the unseasonal spike in vegetable prices (which has almost wholly been the driver of CPI and WPI spike in the November prints). Specifically, the stated reasons ‘to wait before deciding the course of monetary policy’ are as follows:
 
1. There are indications that vegetable prices may already be turning sharply
2. Disinflationary impact of recent exchange rate stability should play into prices
3. Negative output gap including recent slowdown in services sector as well as lagged impact of effective monetary tightening since July should help contain inflation
 
However, the focus on inflation and the risks of waiting for more data are clearly acknowledged as well including the risk that Fed taper may disrupt external markets again and RBI may be perceived as being soft on inflation. Furthermore, the RBI sets guidance quite clearly saying that if the expected softening in food inflation does not materialize and does not translate into a ‘significant’ reduction in headline inflation in the next round of data release or if core inflation does not fall, the central bank can act and outside of policy dates if required.
 
Assessment and Takeaways
 
The RBI’s monetary policy stance has been quite consistent over the past few months even though we have not always understood the seeming ad-hoc interventions that they have made from time to time under the new Governor in order to arrest bond yields. We have elaborated on the monetary policy stance in earlier communications. Even though the stance has chiefly been described around inflation, contrary to market expectations, the new governor has never looked to us as a serial rate hiker. Obviously if inflation becomes unhinged then any central banker would act. However, pending that he has sounded quite patient in letting disinflationary forces seep through given the risks of over-tightening in a continued weak economic environment. In fact, what has been quite welcome is Rajan specifically mentioning the leads and lags in monetary policy affecting economic activity and inflation. This had been somewhat lost over the past few years with market getting conditioned to RBI reacting to direction of each previous inflation print.
 
We had expected CPI inflation to start flattening out from the November print itself assuming the month-on-month momentum on vegetables would start to stall. However, this proved more stickier that expected with the effect exaggerated due to disruptions from Cyclone Phalin. Going forward, and also noticed by RBI as well as government officials, vegetable prices have indeed started to correct quite sharply which should lead to the next round of inflation prints being significantly lower. If this gets delivered, the current tightening cycle may indeed have peaked. If not we would expect repo to peak 25 bps higher at 8%; barring always the unlikely event that inflation remains sticky at current elevated levels.
 
Market sentiment has been quite muted lately reflected in bond yields rising despite our anticipated bullish triggers falling in place. These triggers were overnight rates falling and period of heavy bond supply going away with November. Furthermore, we were anticipating OMOs of INR 50,000 crores or more into March end given our liquidity calculations. However, three counter triggers emerged over the past few days that dented sentiment all over again. These are:
 
1. FCNR plus bank borrowing flows picked up strongly over the last part of November thereby exceeded earlier estimates by USD 9 – 10 billion. Since RBI is no longer providing direct dollars to oil marketing companies (OMCs), all of this has accreted to forex reserves and, correspondingly, create rupee liquidity. This has knocked off OMO expectations since as much liquidity has been created by dollar purchases from the RBI.
2. The bond-switch program discussions have resurfaced over past few days. It may be remembered that the government had budgeted for INR 50,000 crores more borrowing to be used only to purchase shorter term bonds from the market in order to smoothen future maturity profile. This would not have counted as net new supply but at the same time would have provided extra duration to the market. This has further contributed to weak sentiment.
3. Uncertainty on future direction of monetary policy got further accentuated by the sharp spike in inflation readings.
 
Looking ahead, market has largely discounted the lack of OMOs and the same is getting reflected in prices. As for the bond-switch, while the uncertainty is likely to sustain, we have assurances from the RBI that it will be done in a non-disruptive manner and largely with institutions that can absorb the longer duration bonds (presumably EPFO, LIC etc). However, till this uncertainty remains the market may be somewhat suspicious of the mid to long end of the curve. But what is also true is that if inflation were to start delivering the right cues, market may start looking through this uncertainty and may in fact start to desire the higher duration.
 
From our perspective, we have moved some part of our exposures from the long end to the 2020 – 23 segment; respecting the near term headwinds to the longer end owing to bond-switch uncertainties. Besides this change, we haven’t changed our investment levels in our bond funds.
 
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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Tax Planning…Beyond 80C

By: Punam Sharma

As we close in near the end of the current financial year (ends in March 2014), most individuals who are liable to pay taxes are seen rushing around to make investments to minimise their tax liability.
 
Ironically, however, most of us who plan our taxes near the end of the year end up paying more taxes than we are obligated to.
 
Why? One reason is lack of sufficient time to conduct the tax-planning exercise. And the second reason is that most of us are not aware of the tax benefits we can claim.
 
If you have sailed in a similar boat in the past, or are doing so this year, it’s high time you get more aware about the various income tax benefits you can claim to lower your tax liability.
 
What is more, you need to look beyond the most common Section 80C benefit that allows you to invest Rs 1 lakh a year in certain instruments (like ELSS schemes of mutual funds) and provides tax exemption on the same.
 
Look beyond Section 80C
For salaried individuals whose gross total income exceeds Rs 250,000 per annum, deductions under Section 80C may not be sufficient to reduce the overall tax liability.
 
That is why you must look at these eight exemptions that can reduce your tax liability more than what 80C can help you do –
 
1. Mediclaim: You can claim tax deduction under section 80D for mediclaim policies. Under this section, the premium you pay during a financial year on the medical insurance policy for yourself and your dependents is reduced from your taxable income. A maximum deduction of Rs 15,000 is allowed for exemption annually for medical insurance of self, spouse and dependent parents/children is. In case you also pay the premium for your parents (whether dependent or not), you can claim an additional maximum deduction of Rs 15,000.
 
2. LIC premium: Under Section 80DD, any premium you pay to LIC or any other insurance company (approved by the Income Tax board) for the medical treatment of a dependent physically disabled person – like your spouse, children, parents or siblings – can help you avail tax exemption. The limit of deduction under this section is Rs 50,000 but has been raised to Rs 1 lakh for severe disability.
 
3. Medical treatment expenses: Any expense you incur on medical treatment of self or your dependents – up to a maximum of Rs. 40,000 or the actual amount paid, whichever is less – can help you claim tax deduction under section 80DDB. To claim a deduction under this section, you need to submit a medical certificate from a doctor working in a government hospital.
 
4. Interest on education loan: Any interest you pay on loan taken for pursuing higher education of self or any dependent is exempted from tax under section 80E. This deduction is applicable for a period of eight years or till the interest is paid, whichever is earlier. You can claim this deduction only for higher education, including vocational studies pursued after completing the senior secondary examination or equivalent.
 
5. Interest on home loan: A newly announced section 80EE will enable you to claim a deduction for interest paid on a home loan during the financial years 2013-14 and 2014-15. However, the benefit is more for individuals having annual income of above Rs 6 lakh since the additional benefit can only be absorbed beyond this level. It’s important to note that this deduction will be over and above the deduction of Rs 150,000 allowed for self-occupied properties under section 24 of the Income Tax Act.
 
6. House rent: If you are a salaried or self-employed person staying in a rented house and do not receive any kind of HRA, you can claim a deduction under section 80GG.
 
7. Donation: Under section 80G, you can claim a deduction on any donation you make during the year to trusts, charitable institutions and approved educational institutions. The exemption can be up to 50% or 100% of the donations made.
 
8. Political donation: Any donation you make to a political party or electoral trust is eligible for tax exemption under section 80GGC.
 
Your Next Step
 
As you just read, there are several sections apart from 80C that can help you benefit from tax exemptions. So it is time you start looking beyond 80C for tax savings. But you can do this only when you start planning your taxes early in the financial year (April to December) instead of during the final stages (January to March).
 
An early start to your tax planning exercise will not only help you save more tax, it will also help alleviate the stress that accompanies planning and paying taxes.
 

Disclaimer:
 
Mutual Fund Investments are subject to market risks, read scheme related documents carefully.
 
The information set out herein is for general purposes only and is not an offer to sell or a solicitation to buy/sell any units of schemes of IDFC Mutual fund. The information set out is neither a complete disclosure of every material fact of the Income-tax Act, 1961 and/or income tax rules, nor does constitutes tax or legal advice. Investors should be aware that the fiscal rules/ tax laws may change and there can be no guarantee that the current tax position may continue indefinitely. In view of the individual nature of the tax consequences, each investor is advised to consult his/ her own professional tax advisor. The information/ data herein alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy and should not be construed as investment advice. Investors alone shall be fully responsible / liable for any decision taken on the basis of this document. Neither IDFC Mutual Fund/ IDFC Asset Management Company Limited nor any person/institution connected with it accepts any liability arising from the use of this information. The investors should before investing in the Scheme(s) of IDFC Mutual Fund make his/their own investigation and seek appropriate professional advice.

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