India-Pakistan strain: 5 things investors should know4 min read . Updated: 04 Mar 2019, 08:00 AM IST
- Tension between India and Pakistan may affect some of your investments
- Equity investors are not expected to suffer in the long term from the current tensions, but debt investors should stay with short-term or liquid funds
Last week, as tension between Indian and Pakistan escalated, a lot of people wondered how their investments would be impacted and how they should respond to the situation. We spoke to some experts to give you some answers.
Ways to contribute
Some commentators have asked investors to buy stocks and bonds out of a sense of patriotism in order to do their bit for the country. However, experts advise against this and instead suggest other ways of contribution. “Supporting the country by buying stocks is not the best way to go about it. You can use a dip to acquire additional stocks, but this should be based on your investment outlook and asset allocation," said Amol Joshi, founder, Plan Rupee Investment Services.
It’s important that your investments are solely inspired and guided by your financial goals, but if you feel like contributing financially, you could consider donating your money to the government’s relief funds like the National Defence Fund and the PM’s National Relief Fund. The National Defence Fund is used for the welfare of members of the armed forces and their dependants, while the PM’s National Relief Fund is used to help victims of natural disasters as well as accidents and riots. These funds are listed under Section 80G of the Income Tax Act, 1961 and your contributions qualify for a tax deduction.
Debt funds at risk
Whenever cross-border tensions escalate, it typically involves higher defence expenditure, placing stress on the fiscal deficit. The government’s fiscal deficit has already breached the targeted ceiling for FY 19, at ₹7.7 trillion versus the targeted ₹6.34 trillion. A further hit to the fiscal deficit can cause interest rates to increase due to higher government borrowing.
This will pull down returns on debt funds, particularly on medium and long duration debt or gilt funds. “The immediate impact of higher geopolitical risk is on debt rather than equity investors. Investors following a debt-oriented strategy premised on lower interest rates should reconsider their options," said Vishal Dhawan, founder and CEO, Plan Ahead Wealth Advisors.
Lakshmi Iyer, head, fixed income, Kotak Asset Management Co. Ltd echoed the concern. “Despite the recent RBI rate cut and open market operations announcements, higher fiscal deficit, political tension and geopolitical uncertainty have unsettled the debt markets. Investors will be better placed in short-term funds on a risk-reward basis rather than long duration funds," she said.
Experts expressed confidence in equities amid geopolitical tensions despite short-term volatility. On the day of India’s strike on Balakot, the Nifty dropped by close to 1% before recovering to close about 0.45% lower. On the next day, the Nifty rose by almost 1% and then gave up all its gains to close 0.34% lower.
“A lot of negativity has already been factored in. There may be some short-term impact but a long-term negative impact on equity markets is unlikely," said Radhika Gupta, CEO, Edelweiss Asset Management Ltd. She also pointed to the relatively strong performance of markets during historical periods of war such as the Kargil war.
Higher defence expenditure has acted as an economic stimulus on some occasions in history although economists do not expect it in the current situation. “A lot depends on whether the spending is on domestically produced equipment or imported equipment. Historically, India has been a large importer of arms and equipment. There can be some stimulus due to higher defence outlays but I do not expect a major impact as happens in countries like the US which have a large domestic defence industry," said Madan Sabnavis, chief economist, CARE Ratings Ltd.
Gold not a hedge
Financial planners and advisors have not recommended increasing allocation in gold as a means of protecting your portfolio from geopolitical risk or increasing liquidity.
“At present, credit and debit cards and even mutual funds provide sufficient liquidity. You do not need gold for liquidity purposes. Over the long term, gold has not beaten inflation and it should not be more than 5% of your portfolio," said Joshi.
Other experts acknowledged the role of gold as a hedge against the rupee, which could fall in times of extreme geopolitical tension. However, since we are currently nowhere close to a situation like that, planners have ruled out gold as a hedge. “A higher gold allocation is useful as a hedge against the rupee but there is no reason to believe that the India-Pak tension will shift the global price of gold higher," said Dhawan.
Higher tax unlikely
Higher taxes are one way of financing an international conflict but experts do not see it is likely to happen in India. “I do not see higher defence spending necessarily leading to higher taxes. Indirect taxes have been more or less frozen by GST and direct taxes are also on a downward path. A higher fiscal deficit financed by borrowing is more likely. The Fiscal Responsibility and Budget Management (FRBM) Act, 2013 also allows a higher fiscal deficit in the event of war. At most there may be some kind of war cess if the conflict gets prolonged," said Sabnavis.
However, after the election, the government may revive the drive to increase the tax net as it did during times of demonetisation and GST but has been on hold over the last few months, said Shyam Sekhar, founder and chief ideator, iThought. “Pakistan’s own precarious financial situation makes escalation of this conflict less likely," he said.
Even as cross-border tensions are in the news, there is no real reason for investors to panic. Keep your financial goals in focus and invest accordingly.
Equity investors are not expected to suffer in the long term from the current tensions, but debt investors should stay with short-term or liquid funds. Gold may see a short-term rally and can be a hedge against rupee depreciation, but there is no compelling argument to shift to the asset as yet.
Above all, investors should think rationally and not emotionally while making their investment decisions.