Stop chasing physical assets

This might be the time to switch from gold and real estate to financial assets

After the dismal macro-economic scenario of the last couple of years, we are now seeing a gradual improvement. This is noticeable in the declining trade deficit primarily due to a drop in imports, the fall in the current-account deficit to 0.9 per cent of GDP for the quarter ended December 2013 from a high of 6.5 per cent for the quarter ending December 2012, a deceleration in the rise of Wholesale Price Index (WPI) and the Consumer Price Index.

The CPI, which has been stubbornly resisting a decline, has now started reflecting the reversal in vegetable prices and the improving current-account deficit. Headline WPI, which had nearly hit 12 per cent in February 2009 was 4.3 per cent in February 2014. A cautious Reserve Bank of India, which has until now preferred inflation control over growth, is closely monitoring the gradual decline in inflation rates, raising the possibility of lower interest rates in the near future.

The steady improvement shown by these indicators, coupled with a highly probabilistic scenario of a stable government at the Centre, post-elections in May 2014, would now shift the focus to economic growth

Back on the growth path
Two key aspects that augur well for India's economic growth are its urban sector and infrastructure development. India's urban sector, which constituted about 45 per cent of GDP in the 90s, is today 63 per cent. This has been an important impetus in India's economic growth over the last decade. Urbanisation which is currently at about 31 per cent will only accelerate in future

While, so far, the focus has been mainly on rural growth, it would now shift to urban growth especially in relation to urban consumption, services, employment and infrastructure.

To facilitate economic growth, improving infrastructure will be one of the top priorities of the government. Higher expenditure in this area would increase employment, consumption and savings. In addition, this would provide further impetus to policy reforms.

Policy reforms underway, such as liberalisation of FDI limits in telecom and defence, allowing FDI in multi-brand retailing, civil aviation, broadcasting, reduction in fuel subsidies due to the increase in diesel prices, divestment in PSUs and passage of the Land Acquisition and the Pension Bills would also provide the necessary fillip to business sentiment.

The combination of improving macro-economic indicators, focus on growth and an imminent reduction in interest rates clearly put forth a strong case for investing in equity and debt.

In the last few years, Indian investors have steadily increased their investments in physical assets such as real estate and gold. With indicators now clearly favoring equity especially in the mid- and small-cap spaces, investors must return to equities in order to participate in future gains.

Ripe for equity investing
Indian stock markets (as represented by the S&P BSE index) touched a high of 21,200 in January 2008. After more than six years, it has now crossed that. Meanwhile, during this time, the earnings of the 30 companies that comprise the Sensex have grown from Rs 833 crore to Rs 1,295 crore, a 55.5 per cent rise. Market capitalisation of the Indian stock market (aggregate value of all listed companies) which was 103 per cent of GDP in 2008 is now at a mere 60 per cent.

Further, within equity markets, while the Sensex constituting large-cap companies has now fully recovered, surpassing its previous high of 2008, mid-caps and smaller companies, represented by the BSE Midcap Index, has yet a long way to go in providing attractive investing opportunities. Compared to the Sensex, which had touched 21,200 in January 2008 and has now crossed that, the BSE Midcap Index, which had touched 10,113 in early January 2008 is now only 6,769, 33 per cent below its previous high. Clearly, the mid- and small-cap space is a strong case for equity investing for significant capital appreciation.

Debt's also in a bright spot
With respect to debt investing, the need for economic growth would compel the RBI to reduce interest rates. In the last 11 years (2002 onwards) interest rates have fluctuated between 10.4 per cent and 4.75 per cent. Whenever the interest rate has moved up, economic growth suffers. At 9 per cent plus, the RBI needs to intervene to bring it down. Between 2002 and 2004, the rate was gradually reduced (from over 10 per cent to under 5 per cent) and again in 2008 from approximately 9 per cent to under 5 per cent.

Inflation in FY 15 (as indicated by both the WPI and the CPI) is expected to be significantly lower (WPI: 4.5-5 per cent; CPI: 7-7.5per cent) than in FY 14. The lower CAD, at about 1.5 per cent of GDP, would result in a stable currency. These, and moderate credit growth, all augur well for lower interest rates ahead.

Now that key indicators show that the government has successfully managed to bring matters under control, the need for a fillip to economic growth is evident. For the year ending March 2013, the Indian economy grew at a dismal 4.5 per cent, the lowest of the past decade. It would need to grow at about 5-5.5 per cent over the next few years to regain lost ground. For growth to take place, companies need to borrow to set up new projects, which, in turn, would increase employment and result in a higher growth in trade.

However, at present companies are unwilling to borrow at the current high rates of interest; doing so would render their projects unviable. Clearly, the need of the hour is to reduce interest rates to trigger economic growth.

With the hope that crude oil prices are in control and that no geo-political events impact growth, policy reforms, decline in interest rates, repair of government, corporate and bank balance sheets, kick-starting of the investment cycle within the overall framework of a decisive and stable government at the Centre indicate the start of a secular bull run providing very attractive opportunities for equity investors with a three to five year investment horizon as also to debt investors due to declining interest rates.

The writer is MD & CEO, ICICI Prudential Mutual Fund