Keep expectations in check

After the government made a flurry of reformist announcements last month and withstood immense pressure from coalition allies to roll back its decisions, there were widespread expectations the Reserve Bank of India (RBI) would lend a supporting hand and help fructify the government’s growth-enabling plans. But, RBI, despite immense pressure from the government and industry — acting like a true central banker — merely cut the cash reserve ratio (CRR). by a token 25 bps and left the repo rate unchanged, indicating it intended to maintain a monetary policy in line with the objective of containing inflation.

While RBI did not provide the near-term impetus that most equity markets love, with its actions, it has clearly established the independence of the central bank in the country. This will go a long way in enhancing the stature of the country as a good investment destination. India would not just be considered a democracy with an independent judiciary and free media but also one with an independent central bank. None of the other BRIC members can claim these credentials.

Just a day before the monetary policy announcement, the finance minister unveiled a new fiscal consolidation road map, wherein he revised the 2012-13 fiscal deficit (FD) target from 5.1 per cent to 5.3 per cent along with a plan to bring it down to three per cent by 2016-17. However, given the current scenario (slowing growth) and forthcoming general elections, it is difficult to believe the government would be able to bring down the fiscal deficit in the current and next years to levels envisaged in the road map.

The high fiscal deficit, in turn, is feeding into inflation which continues to stay sticky at high levels, even as growth has slowed down considerably. Years of high inflation and a loose fiscal policy have combined with policy paralysis to pull down the potential growth rate of the economy. RBI now puts the potential growth rate of the economy at seven per cent, which should be a wake-up call to those expecting the economy to cruise to eight per cent growth in the normal course of things or believe a couple of rate cuts can do the job. The road to eight per cent growth would need to first involve bringing down both inflation and inflationary expectations, thereby incentivising higher saving, which would then have to be routed into investments by removing bottlenecks. None of these will happen in a hurry.

So, what do all these mean for small investors? Small investors must remember the fundamental rule that a bond prospers when an economy declines. Interest rates will definitely fall, albeit at a slower pace than what the equity market would like to believe. As a result, in the medium term, bonds should outperform equity.

But, if one has a longer perspective, then he/she must explore the equity market at the current stage. The valuations are extremely skewed and certain pockets in the market are very attractively priced. Net of few frontline defensive stocks in the index, the market is valued just 10 times forward multiple. Falling interest rates and commodity prices will improve the return on equity of corporate India going forward, which, in turn, should attract further investments in equity. However, one cannot time the market. Therefore, one has to assess his/her risk appetite and liquidity needs, allocate the investible funds between equity and bond accordingly and adopt a disciplined investment approach. And, keep expectations in check.

The author is chief investment officer, AEGON Religare Life Insurance