The Economic slowdown has become a common phenomenon globally. While events such as Brexit highlight the side effects of globalisation on domestic job creation and national welfare schemes, economic integration results in spreading of the contagion of slowdown from one economy to the other. In spite of these hurdles, a few economies manage to grow at a faster pace as compared to the majority of other economies in the word. At the moment, India is one such bright spot. Though the World Bank President acknowledged India’s growth story recently, it would be inappropriate to say all’s well with Indian Economy.

India faces some challenges...
India, despite major efforts, are still unable to surpass the target of 8.0% GDP growth. Attaining pre-global financial crisis levels looks like a pipedream at the moment. Indian banks, especially the public sector banks have been facing a persistent problem of deteriorating asset quality. India’s consumption demand is down due to inflation that sustained at higher levels for years. Although in recent times, retail inflation, as measured by the movement of Consumer Price Index (CPI), has been moderated considerably, household expectations of inflation are still higher. This has resulted in the softening of demand. Deteriorated corporate balance sheets and higher borrowing rates have been delaying recovery in India’s investment cycle. The Government has been trying to boost infrastructure expenditure, but that has been proving to be inadequate in pulling up the economy from the grip of stagnation.

7th Pay Commission—a fiscal stimulus:
On this backdrop, the Government has decided to give a booster shot, a stimulus to the Indian Economy. Recently, the Government accepted the recommendations of the 7th pay Commission. The Central Government will spend Rs 84,900 crore on salaries and pensions of which the Budget 2016-17 has allocated Rs 60,600 crore. The budget of Railways to accord pay hikes has been Rs 24,300 crore. Implementation of these recommendations will ensure a substantial rise in the purchasing power of about 1 crore citizens. In line with this action of the Central Government, even States may follow suit. The number of State Government employees and pensioners together makes up nearly 3 crores personnel. In other words, close to 4 crore Indians will have about 20% to 25% more money.

Positive impact:
Needless to say, such a high dose of fiscal stimulus would help to revive consumption demand and quell worries of households about inflationary pressure on their budgets. According to Kotak Economic Research Analysis cell, Rs 46,800 may come back to the economy in the form of spending while the Government’s tax revenue is expected to go up by Rs 13,000 crore. The domestic savings will be to the tune of Rs 25,000 crore.

The past experience suggests that Auto companies and those involved in the Consumer Durable Goods and FMCG companies are likely to the primary beneficiaries. The RBI has been nudging banks to lower lending rates to achieve monetary transmission. The Central Banks opines that it has been reducing policy rates, but banks have been reluctant to pass on the benefits. If banks reduce lending rates further, it would further boost the demand for automobiles. The combination of higher discretionary income and lower interest rates may also give a boost to the sinking real estate market. At present, the sector is grappled with unique problems of higher inventory and lower working capital and massive debt on books. Higher consumption and demand may create more jobs eventually.

What are the negatives?
When 4 crore people spend more, it is a given that inflation is going to rise. The RBI has set a target of curbing the retail inflation to 5.0% by the end FY 2016-17. The pay hike poses a threat to that goal.

Impact on future monetary policies...
Now it is clear that Dr Rajan will go back to academics after his term ends in September 2016. The Government has got the tough man out of its way (unfortunately though). It recently gave a go-ahead to the formation of a 6-member monetary policy committee. The said committee will have 3 Government nominated members, and the other 3 will represent the RBI. Although the RBI Governor may have a deciding vote, a veto, to exercise in the case of no consensus among team members, who will hold the Governor’s position still remains under the wraps. Another interesting point is there’s still no inflation target been given to the monetary policy committee. This leaves enough doubts to believe that the Government is considering the possibility of revising the inflation target upward. Undoubtedly, this would be the impact of the implementation of 7th Pay Commission.

Comments of the Finance Minister, Mr. Arun Jaitley, while speaking to media on the implementation of 7th Pay Commission are telling. He said, “It will generate demand, but more money supply will also impact inflation. So it is a mixed bag.”

Impact on capital markets...
Any rise in inflation will be a negative for debt markets. Although, the fiscal deficit may not have much impact, considering that the Government has already provided for the majority of expected outgo for this fiscal in the Budget, the actual impact still remains to be seen. On account of the budget deficit subsequently going up after implementing the recommendations in the future, debt markets would react negatively. At present, the RBI stance of the monetary policy has been accommodative. But after reviewing the impact of 7th Pay Commission on inflation, if the policy stance changes to neutral or becomes restrictive, the debt markets may react negatively.

On the other hand, pickup in demand would result in higher revenues for companies forming part of consumption theme. This may provide some respite on the market valuations front, which at present are high due to stagnation in corporate numbers. With revenues of companies going up, the valuations may come down in future, leading to stock market indices continuing the rally. Shrugging off the risk aversion that gripped Indian markets around Brexit, investors seem to be looking up to buy Indian equities. S&P BSE Sensex has been inching up towards reclaiming its all-time high. Good monsoon and the absence of any new negative development on the global front have been getting investors, sitting on sidelines so far, back to markets.

What investors should do?
Investors should avoid speculating on the market movement and would be better off if they stay cautious than overly optimistic. It is noteworthy that, the positive impact of 7th Pay Commission may already have been factored in. Therefore, avoid taking concentrated bets following market rumours and high expectations; also avoid sector funds as they are perilous. Rather invest in opportunities funds which carry diversified portfolios and are better placed to reap benefits of any upside left in the current market rally.

If you are investing in debt funds, you should first look at your time horizon and the maturity profile of the scheme you are looking to invest in. Unless they match, there’s always a high risk involved with investing in debt funds. At present, flexi debt funds look better placed to ride of uncertainties that prevail on the back of higher inflation expectations and recent changes to the monetary policy structure.

PersonalFN believes smart investors focus on their financial goals and invest as per their personalised asset allocation and risk appetite. Speculative approach to investing often leads to a catch 22 situation and wealth erosion.
 

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