If you do not have enough of financial assets, both equity and debt, you should invest in them now as the credit policy has set the recovery ball rolling
There were several highlights in the Reserve Bank of India’s (RBI) the credit policy (announced on 29 September), but a significant one was that it has shifted the economy to a higher gear. Every economic recovery has its fair share of sceptics in the initial stages. However, the macro-economic adjustments in the economy that has been going on for some time now and the domestic reforms, have mapped out a sturdy path for India’s recovery.
Slackening global commodity prices and deflationary pressures across the globe, including in India, were among the main reasons for this optimism. Hence, the 50 basis point-rate cut didn’t surprise us (one basis point is one-hundredth of a percentage point). It’s a big, much-needed thrust for the Indian economy.
We are still in the early stage of recovery. The rate cuts will boost demand, reduce interest costs, and improve profitability in critical sectors such as infrastructure, engineering, construction, and consumption. Over the next three years, this will pave the way for earnings recovery, and drive companies to incur capital expenditure.
Another highlight is that the RBI is likely to have an accommodative stance on interest rates in the medium term. There is a strong disinflationary trend seen globally as commodity and food prices have reduced significantly. The price of Brent crude oil has dipped nearly 50% in the past one year to about $45 a barrel. Most commodities are down 20-50%. The lower oil price itself has led to significant savings for the Indian economy.
With input pressures easing, inflation targets have been lowered. The RBI has set a target of 4.5% for consumer price inflation for March 2017, which is considerably low and quite achievable. As a result, there’s plenty of legroom for interest rates to head further south over the next few quarters.
The central bank also noted that real interest rates is likely to be around 1-2%. This should drive investors to seek financial assets as households are unlikely to get real returns from physical assets. Studies have shown that Indian households have been lackadaisical in investing in financial assets, and are overweight in physical assets such as gold and real estate.
A meagre 2.3% of Indian household savings are allocated to equity with mutual funds ownership even lower. Real estate and gold constitute nearly 70% of a household’s assets. And the fact of the matter is that with the current account deficit under control, outlook for physical assets does not look rosy.
To be fair, there has been a slow and encouraging build-up of financial assets, particularly equities. Nevertheless, there’s still a long way to go. The under-investment in financial assets provides a huge gap to be filled over the course of time.
No doubt, investors will benefit from their exposure to financial assets. Both equity and debt look poised to do well. For equity, one should have a longer investment horizon of around 3-5 years at least, and investors should give enough time for the corporate revival cycle to take root.
Interest rates are headed lower. Global commodity prices and other indicators signal that there’s still room for rate cuts. We are somewhere around the middle of the rate cut cycle, which looks good to go for the next few quarters. The RBI has said it would keep the stance on rates accommodative, which will keep rates soft.
In this scenario, debt funds appear well placed to generate returns. A fall in interest rates benefits all the bond funds, but it has a more favourable impact on duration funds, i.e., funds that hold debt of longer tenures. Long-term corporate and income funds and government securities funds appear well placed too. Investors could look across the spectrum of available debt funds for opportunities to invest in.
Duration funds, however, can add more zing to your portfolio. Even if you have these funds in your portfolio, there is good reason to buy more. The bond market is set for some exciting times, and that excitement can be translated into a good investor experience over the next two years. But this opportunity has to be grabbed quickly. Investors will only reap the benefits of the rate cut cycle if they move in as early as possible.
The stock market correction, too, is an inviting opportunity to accumulate good stocks inexpensively. By historical comparisons, we are still in the early stage of a market recovery. India has a strong currency, lower inflation, and improving demand conditions, which will benefit stocks in the long run, so there are no reasons to worry about a correction. Whenever stocks correct, due to a financial turmoil globally or due to foreign investors selling, investors should dip into their reserves and add more equity assets. By staying on the sidelines during volatile times, investors tend to miss bargain sales.
Better days are slated for financial assets in the long run. However, there is still a long way to go till we see over-investments in financial assets. And do not expect returns overnight. This is the time to collect as many units of these assets as possible, and not think of immediate returns.
Nimesh Shah is managing director and chief executive officer, ICICI Prudential Asset Management Co. Ltd.