RBI governor says will not surprise the market with sudden rate hike
India’s central bank, which has been maintaining an accommodative monetary stance despite inflation climbing above its comfort level earlier this year, is unlikely to make sudden shock moves to directionally change the policy rate.
Reserve Bank of India (RBI) governor Shaktikanta Das told a television news channel that the central bank does not want to surprise markets with a sudden rate hike, amid concerns surrounding inflation.
“We are constantly monitoring the situation and we will act at the appropriate time. At the current juncture, we feel that appropriate time has not come,” said Shaktikanta Das.
He added: “All our actions will be calibrated, they will be well-timed, they will be cautious. We don't want to give any sudden shock or any sudden surprises to the markets.”
This should come as a relief to the corporate sector, which is enjoying a low interest rate regime coupled with an ebullient stock market that has been trading at record highs and beating global peers this year.
The RBI had last cut interest rates in May 2020 when it had reduced the policy repo rate by 40 bps to 4% as the growth outlook was sombre. The economy contracted by 7.3% in 2020-21 as the spread of Covid-19 and lockdowns impacted business operations and sentiments.
GDP growth did see a pickup despite a brutal wave of the pandemic in North India as also other parts of the country in the April-May period. Analysts estimate the country’s GDP to grow around 20% in the first quarter ended June after shrinking by a fourth in the same period last year. While the base effect will likely give an artificial push to the growth rate, activity would remain below the pre-pandemic period at an absolute level.
Meanwhile, retail inflation—which is closely tracked by the RBI in framing its monetary policy—has moderated after shooting past the red zone. Retail inflation cooled down to 5.59% in July, coming within the RBI’s target range of 2-6%. It was above 6% in April and May.
According to the RBI governor, the current inflation looks transitory and the central bank expects it to cool down further in the coming months. Part of the rise in inflation was due to rebound in the global oil prices that affects Indian inflation adversely as much of the oil is imported in the country.
Das said while the RBI is watching the revival of economic activity there is still some uncertainty around the pandemic. He added that some parts of the economy, such as the manufacturing and service sectors that are not dependent on physical contact, are showing a rebound.
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Indian investors’ interest in market fascinating, see rating downgrade: UBS
Indian retail investors’ interest in stock markets is “fascinating” as they have been pumping money into both the primary and secondary market despite experts cautioning against super-rich valuations, according to UBS.
The Swiss brokerage and financial services firm said that while offshore investors have turned cautious due to expensive valuations, Indian households have been on a buying spree.
The bullish sentiment is not just restricted to direct participation in the stock market by retail investors. Flows from domestic mutual funds have also turned positive after four quarters, it said.
It raised a question mark whether such a herd push can be sustained as net outflows by foreign institutional investors (FIIs) tend to buttress the fact that valuations have run up too high.
In the current quarter (July-September), FIIs have already encashed $1.1 billion on a net basis as against inflows of $800 million and $7.3 billion in the preceding two quarters.
Even as the FIIs are pulling out money, Indian households have been investing heavily in the market and had a net purchase value of $5 billion in equities in the April-June quarter. This has pushed up direct retail direct ownership at a 12-year high, UBS noted in a report.
UBS said that there is not much wiggle room for further positive re-rating of stocks and sectors given the expensive valuations. It added that if low absolute returns continue that could lead to a fatigue in retail flows and stop the locally fuelled momentum. This could be accelerated by the fact that bank deposit rates, which were sliding and had turned retail investors to look at higher returns from other channels, have likely bottomed out.
UBS also said that it projects the GDP growth rate for the Indian economy for the current fiscal year ending March 2022 at 8.9%, below the consensus estimates. The Reserve Bank of India has forecasted a 9.5% GDP growth for the current year, after trimming it from an estimated 10.5% earlier.
In its base case scenario, it expects India’s economic growth to gain momentum from October 2021. This will be due to pent-up demand (largely led by contact-intensive services, especially after more people are vaccinated), favourable external demand (on strong global growth) and higher government spending, UBS said.
UBS said it doesn’t foresee any meaningful rise in corporate investment in the next couple of years. It also expects inflation to average 5.5% in 2021-22. This will keep the RBI from raising monetary policy rates. Central banks typically raise interest rates when inflation rises beyond their comfort levels.
High debt, downgrade warning
UBS flagged that public debt has climbed to 88% of GDP in FY21, from 72% in the previous year, and said the GDP has to grow at 10% on a nominal basis to make it sustainable.
The brokerage house said that any lags in policy execution and implementation of growth-supportive reform to boost sustainable growth could lead to widening macro stability risks.
“In our base case, we foresee a risk of a downgrade in India's sovereign rating by one of the three rating agencies in the next 12-18 months,” it warned.
What are Additional Tier 1 (AT1) or perpetual bonds
Additional Tier 1 (AT1) or perpetual bonds are now hogging the limelight as large banks including HDFC Bank, Axis Bank are tapping offshore markets for the first time via such instruments. The local market has dried up completely as mutual funds, traditional investors in those papers have shied away.
What is AT1?
It is a kind of bond billed as a quasi-equity instrument. While such securities offer greater returns, the risk is also higher. These add to a bank’s capital strength aiding any bank to maintain regulatory thresholds for capital adequacy, a gauge for accounting compliance in proportion to expanding credit business.
For a corporate, these securities are popularly termed as perpetual bonds, instead of AT1. They do not form part of capital formation unlike banks.
When Bharti Airtel raises perpetual bonds, it is different from that of HDFC Bank raising AT1. Usage is the key differentiator here.
Key features of AT1:
These papers do not have any fixed maturity but generally have a five-year call option, an exit route for investors when issuers call such bonds back after the stipulated period. These papers are always rated three-four notches below the same issuer’s general corporate rating.
What’s the risk element?
These are riskier instruments as repayment obligations come lower in the waterfall mechanism. Those liabilities are not top priority for any borrower/issuer at time of any crisis. The principal or any accrued interest can be written down partly or fully. If a borrower’s common equity tier 1 (CET1) ratio, an international standard for capital, falls to or below 6.125 percent from October onwards this year.
History of investor loss:
On the domestic turf, investors used to presume it as a five-year paper. Borrowers and investors used to agree on an informal agreement that the issuer would call it back after five years.
None thought AT1 would falter. No investment is risk-free in this world as the popular saying goes.
Private sector lender Yes Bank reminded investors of the age-old adage. Under new management it decided to write off the AT1 obligation. Some of those securities were allegedly mis-sold to wealthy investors.
Did Yes Bank trigger panic?
Yes, it did. This prompted regulators like the Securities Exchange Board of India (SEBI) coming out with stricter regulations for AT1 investments. The regulator was concerned over the valuation process by mutual funds that hold a lot of retail investments.
What SEBI did?
The capital market regulator directed mutual funds to cap ownership of bonds with special features at 10% of the assets in a scheme and value them as 100-year instruments from April, potentially triggering a redemption wave. The order came on March 10, 2021.
Later, the capital markets regulator eased valuation rules but with some riders after the finance ministry had asked Sebi to withdraw its order to mutual funds.
Why did the local market dry up?
The appetite for AT1 bonds has lost as fund houses now appear not so keen to buy papers sold by banks/institutions/companies in the local market.
MFs are now often seen highlighting hurdles in valuing those securities following new guidelines by the SEBI.
Between FY18 and FY21, perpetual bonds sales by banks have nearly halved to Rs 18,772 crore from Rs 34,860 crore three years ago, show reported data. Beginning this financial year, the bond street did not have any single issuance on the AT1 lane.
So offshore sales way forward?
Banks barring the State Bank of India never tapped the overseas market for AT1 sales. There was reportedly one issuance by the SBI way back in 2016 for about $300 million.
HDFC Bank set a precedence recently raising the largest AT1 sale offshore for $1 billion. Many more like Axis Bank, Union Bank of India and State Bank of India are in the process of building such issuances, media reports suggest.
What evinced interest for international investors?
Internationally interest rates are at record lows. US Treasury benchmark is still yielding about 190 basis points lower than its near-term high of 3.08 percent in October, 2018. Global central banks have resorted to easy monetary policies, which are unlikely to taper before this year-end at least.
Yield hungry investors are scouting for higher rates of returns especially when equity valuations are seen overshooting.
Will the local market revive for those quasi-debt papers?
Unlikely unless wrinkles are ironed out. Still some large banks will try convincing fund houses, who may bet only after easing of valuation regulation that is unlikely.
The deployable money by fund houses could well find alternatives like investment trusts.
Any scope for secondary market trade?
Like primary sales, the secondary market has also dried up with securities changing hands occasionally. This makes the market more illiquid.
Nippon India MF’s Bhan suggests shifting focus to large caps
Investors looking to bet on mid- and small-cap Indian stocks should be cautious, and should reallocate a part of their portfolio to bellwether large caps, says Sailesh Raj Bhan, deputy chief investment officer for equity investments at Nippon India Mutual Fund.
Bhan, a 25-year veteran in the banking and financial services industry, thinks that large caps offer a better risk-reward opportunity to an investorgiven their relative underperformance versus mid- and small-cap stocks.
Moreover, if post-lockdown recovery expectations are not met, mid- and small-cap shares could see their valuations come under pressure, he said in an interview with Moneycontrol.
Most promising sectors
Bhan thinks that manufacturing and capital goods, large banks, insurance and credit sub-sectors, power utilities and consumer discretionary sectors appear to be the most promising.
Yet another sector, which has seen headwinds even as the Sensex has zoomed past the 56,000-mark, is auto, which could see some disruption, especially in the electric vehicle segment, Bhan thinks.
Bhan says that while earnings are becoming broad-based and are being supported by a global growth, “near-term corrections on account of global factors or the occurrence of further disruption will test the resilience”.
“Also, market euphoria is visible in the mid- and small-cap space which can see a material impact in case rising expectations are not met,” he adds.
Focus on large caps
Bhan thinks that large-cap companies have the ability to deliver market share gains in difficult operating circumstances, and that is precisely what seems to be playing out in the market right now. These companies are also doing most of the heavylifting and supporting earnings recovery.
He says that the top 50 stocks, which make up the Nifty 50, have seen “material consolidation with top players gaining significant market shares like in telecom, banks, steel sector, etc.”
“Sectors which were suffering in the last few years like metals, pharmaceuticals, IT services, etc. have seen a material uptick in the earnings growth in the last 12 months and have contributed to market rerating,” he adds.
Bhan says that given the sharp underperformance of large cap indices vs mid and small-cap space over the last 12 months, the case of large caps investing is favourable.
“Recent market shifts where largecaps have started outperforming lately over mid and small caps do reflect the shift in sentiment and focus on investors in reducing overall portfolio risk and choosing the large cap space,” he adds.
Bhan says that his fund benefited from focussing on undervalued sectors including engineering, large metals and pharmaceuticals in the last one year.
“A differentiated portfolio created out of high conviction investing has been a key factor of our Nippon Large Cap Strategy. The fund focused on areas where growth was strong, while valuations were relatively attractive,” he says.
All you want to know about RBI’s sovereign gold bond series VI
The Reserve Bank of India (RBI) has come up with the sixth tranche of the popular sovereign gold bonds (SGBs) scheme that allows retail investors to invest in gold at discounted rates and to earn tax-free capital gains on their money.
When does the scheme open? When will I get the bonds?
The new scheme, for the current financial year, opens Monday. It will remain open for subscription for the next five days. The bond certificates will be issued by September 7.
Does the SGB scheme allow me to own actual gold?
Not really, but you get to invest in an instrument whose price is pegged to the price of gold. Simply put, the value of your investment will go up or down with the prevailing market price of the yellow metal.
But why are these bonds better than holding physical gold?
They are better in that you do not have to worry about safe keeping or theft. You do not need a locker as you do for physical gold. On top of that your investment earns you a nominal 2.5% interest every year, irrespective of whether the price of gold goes up or down.
Finally, there is no question of a metal of lower purity, as often arises when it comes to unmarked physical gold. Also, there are no making charges, like in the case of jewellery.
How are SGBs different from owning digital gold?
For one, digital gold can be converted into physical gold after a certain lock-in period or whenever you want it, prematurely. Second, each time you buy digital gold you have to pay the Goods and Services Tax (GST), which shaves a portion off your final return, as it adds to your cost. When it comes to SGBs you do not have to pay any GST.
But do I have to pay capital gains tax on SGBs?
No. If you hold your bonds till maturity, you don’t have to pay any capital gains tax.
Moreover, even if you exit before maturity, your capital gains are indexed, so it is beneficial for you. This is where SGBs score over digital or physical gold.
What is the issue price of these SGBs?
The central bank has kept Rs 4,732 per gram as the issue price for the sixth tranche. Those applying online and paying digitally will get a discount of Rs 50 per gram.
Are there any investment limits?
There is a minimum investment requirement of one gram. Individuals and Hindu Undivided Families can buy a maximum of 4kg worth of bonds. Trusts can invest in SGBs up to 20kg.