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Investment Insights

Suyash Choudhary

As the prospects for the first US Fed rate hike draw near, a justifiable question that investors would have is whether RBI can cut rates further when the Fed is hiking rates. We think yes and we explain our rationale via the series of charts below.

 

 

The above chart tracks the last Fed rate hike cycle between 2004 and 2006. Indeed, the RBI was also hiking into the cycle. This phase coincided with a significant commodity upswing as the CRB commodity index chart below demonstrates. Therefore, and as will be shown below, RBI rate hikes were necessary to keep real policy rates static. As is also evident from the same chart, we are now clearly in a reasonably sized global commodity downswing that started since 2011 coinciding with the Chinese industrialization cycle turning (Chinese PPI has now been falling since 2011 and been in outright deflation since 2012 as shown in the same chart)

 

 

Next look at the chart below that tracks US real policy rate (Fed funds minus Core PCE) and India real policy rate (RBI repo minus CPI industrial workers). CPI IW has long period history and tracks composite CPI closely.

 

 

Average real Fed funds rate between Jan 2003 – Dec 2004 was -0. 5%. Between Jan 2006 – Dec 2007 it averaged 2.8%.  That is a massive swing and much more than anything potentially feasible in the current cycle (most predictions are for real Fed Funds rate to peak at 0% from approximately -1% now, as nominal rates will be hiked to 2% even as inflation rises to 2%). RBI’s real policy rate averaged 1.1% between Jan 2003 – Dec 2004 and 1% between Jan 2006 – Dec 2007.  So there was little change in our real rates over this massive Fed rate hike cycle. One large reason we could manage such a large narrowing of real rate differential (in fact the real rate differential turned negative between 2006 – 07) is explained below:

 

 

Our basic balance (CAD plus FDI) was close to zero through 2008 which meant that our reliance on the volatile component of global capital flows was minimal. The same is borne out by tracking CAD which was at its worst around 1% of GDP during this period. Contrast this to 2010 – 2013 period where narrowing of real interest rate differentials also coincided with worsening CAD and basic balance. Little wonder then that we eventually had a funding crisis on our hands in 2013 inviting emergency measures. However, now the CAD and basic balance metric is back to resembling the 2005 – 2008 period which is consistent with a much narrower real interest rate differential without inviting any sort of a funding crisis.

 

So in summary:

 

1. The last Fed hike cycle was alongside a global commodity lift off and also ran coincident with RBI rate hikes. The situation today is of the global commodity cycle having turned sustainably for the past few years and lately showing further signs of a break down.
 
2. In terms of real rate differentials, Fed real rates rose on an average from -0.5% to 2.8% in the last hiking phase, even as our average policy real rates remained static through that phase at around 1%.
 
3. A significant reason why this could happen is that our sustainable external account (measured either in CAD or basic balance terms) was very comfortable. We are back to that phase over the past 1 year.

 

 

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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IDFC Mutual Fund

Our foremothers saved money from their monthly allowance provided by husbands towards future security of her house. However, with the changing times, the millennial couples now believe to save together for the security of their households. But how much do they even talk about money? According to a recent survey it is revealed that couples who discuss money at least once a week are happier than those who talk less frequently about money matters. In the yesteryears, asking a man’s salary was considered inappropriate but now “not knowing” would be considered inappropriate. To add to it, relationships also break on the basis of financial infidelity. Now, you sure want to avoid getting your relationship in trouble!

 

Below is the result of the survey that we conducted on Facebook page through our contest.

 

 

Survey conducted on our Facebook page, reveals simple secret to happy marriage –

 

1. Discuss money matters at least once a week to ensure neither of the two are swaying from their drawn budgets.

2. Build an emergency fund of 6 months to pay off any essentials.

3. To help achieve your short terms goals, like a foreign trip, car, or even starting a new venture, invest in funds with a horizon of 1 – 5 years.

4. Long term goals like retirement, child’s education or even buying a house, invest in funds with 5 years+ horizon.

5. While a joint bank account helps in matters like applying for a home loan etc., but it’s important to have your own financial independence.

6. Don’t be too harsh on yourselves, have a “fun fund” and splurge smartly.

7. Insurance is an investment towards an uncertain future. It’s wise for the couple to have their independent insurance policies.

8. With the rising medical costs, it’s important to have a medical insurance.

 

To ensure you achieve your goals, please consult a financial advisor for investment purposes.

 

Source: Our users on Facebook have contributed ideas as well: http://tinyurl.com/pmma8oz

 

 

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Suyash Choudhary
    While there cannot be any reasonable complaints with the pro-activeness displayed with respect to rate cuts so far, RBI’s forward guidance itself may have somewhat muted transmission by focusing market attention on short term supply side factors like rains and oil; and thereby keeping expectations in a state of flux. This has been readily visible in bond markets which after all have to be considered as the first port of transmission for any policy signal. Although to be fair bond markets also have had to contend with the volatility in global bonds over this period. 

     

    Partly owing to this forward guidance and partly eyeing the 4% ultimate CPI target, many market participants may have formed rather closed ended views with respect to how much more this rate cycle has to run. Indeed, we also haven’t had visibility on rate cuts beyond repo of 7% thus far. Our logic for this has been this: CPI seems to be stabilizing around the 5 – 5.25% band (on an average annual basis) whereas RBI had earlier indicated a preference for keeping real policy rate of 1.5% – 2% over CPI. Hence, so long as we were reasonably confident that CPI is indeed tracking 5%, we were happy to hold a view of 7% on repo rate. We had however kept this view open-ended, keeping in mind that this is an evolving cycle.

     

New developments have been forthcoming over the past months on the real rate debate. The biggest new development is from Rajan himself. In the conference call after the June policy when asked over what time frame one should look at  real interest rate of 1.5% – 2%, he said this: “This is somewhat a loose concept, but I think over the span of the next year, we should see incremental over the year, you should probably make about 1.5% to 2% on your savings. Of course, there is a term structure of interest rates and so on, so I am not delving deep it into it. This is somewhat loose statement, but it is saying that investors should expect. I am not talking about the overnight rate, I am talking about short term up to about a year, year and a half, that kind of”.

 

This suggests to us at worst that the anchor rate that determines compensation of 1.5 – 2% over CPI is still fluid in the Governor’s mind. At best it indicates that RBI can potentially see room to cut repo rate all the way to a place where the 1 – 1.5 year fixed deposit rate provides 1.5 – 2% compensation over CPI. In any case, what is clear is that the ‘Repo minus CPI equals 2%’ equation that has guided thinking so far may not necessarily hold and the RBI may eventually respond to other pressures. What is also relevant to this is a debate that the chief economic advisor has recently ignited as to which inflation metric is the right measure to use when assessing real rates. In an environment where CPI is 5%, WPI negative and GDP deflator zero;  real rates can look staggeringly different depending upon which inflation metric is chosen.

 

We think that this whole debate will eventually settle as follows: So long as government continues to be proactive on food price management, resists the temptation to unleash a consumption stimulus and thereby incrementally continues to curb volatility in CPI around the 5% mark, the RBI will not really fuss too much the miss of its 4% target. This is palatable since longer period stability around the 5% mark will substantially address fears of the 4% +/- 2% target getting compromised sustainably from 2018 onwards. Of course, the RBI will need to take a forward view to see whether government policies, global disinflationary forces, and local growth  give them enough confidence with respect to sustainability of 5% CPI. In our view there is abundant reason to believe that this will be the case. Finally, the real rate delivery necessary to keep financial stability anchored doesn’t need to be versus the policy repo rate. In short, we think that RBI’s current policy framework allows for deeper rate cuts ahead provided, of course, the current anchor on inflation is sustained.

 

The charts below are meant to highlight 3 things:

 

  1. 1. Monetary aggregates in India today are quite restrictive compared to history (chart on India M3)
  2. 2. The state of local economy (chart on India PMI)
  3. 3.The state of world growth (chart on base metals)

 

Please note that we are by no means claiming that one chart per indicator constitutes the total assessment of the indicator. Nevertheless, these data are telling and indicate that the debate on RBI policy framework is likely to be resolved sooner rather than later.

 

 

 
 

 
 

 

 

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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