In recent times, as many of you may be aware, the global growth has been rather uneven and slower than expected. In the Advanced Economies (AEs), activity has weakened and even the Emerging and Developing Economies (EDEs) are experiencing a slowdown. After the Federal Reserve Chairman, Mr Ben Bernanke hinted at winding down its bond-buying programme nervousness has gripped the global economy, although a statement was issued later by Federal Reserve Chairman saying that the U.S. central bank might not roll back its stimulus programme earlier than expected. This made the U.S. dollar strong vis-à-vis the Indian rupee and also other currencies in EDEs. In the Euro zone, while U.K. has depicted some recovering backed by gathering of momentum on the back of consumer spending, the Euro zone as whole is grappling with recession and double-digit unemployment rates. Speaking about China, although it maintained momentum in the recent months, the HSBC Purchasing Manager Index (PMI) numbers and industrial production aren't depicting any virtuous picture. Likewise with Brazil, Russia and South Africa, growth has clearly lost momentum. Japan's economy though, is returning to positive growth supported by their industrial production numbers and retail sales. So, the global economic headwinds remain.

Speaking about India, the foreign exchange management has got under stress since late May 2013 prompting the Reserve Bank of India (RBI) to step in by increasing short-term rates and contract liquidity, to curb the falling rupee. As regards the economic activity is concerned, risks to growth have increased notwithstanding the robust onset and spread of the monsoon. There's been in a lull in industrial activity as well, and so has the confidence being hampered. It is noteworthy that although the manufacturing PMI has increased modestly in June, the pace of expansion seemed anaemic. The deceleration in new orders growth reported in the Reserve Bank's Order Books, Inventories and Capacity Utilisation Survey (OBICUS) indicates low activity levels in Q1FY14. This is corroborated by the Reserve Bank's Industrial Outlook Survey (IOS) which indicates that the overall business sentiment remained subdued in Q1FY14 and may improve only marginally in Q2FY14. Early results of corporate performance in Q1FY14 suggest that sales growth and profit margins remained subdued. The headline inflation (as measured by the Wholesale Price Index inflation) however has mellowed to a 3-year low of 4.86% and has depicted signals of moderation. But now since Brent crude oil prices are elevated and rupee has depreciated, inflationary pressures remain.

  WPI Inflation mellowed down further

Data as on June 2013
(Source: Office of the Economic Advisor, PersonalFN Research)

 

The Consumer Price Index (CPI) inflation after moderating somewhat during April-May, it has once again surged close to double digits in June, driven primarily by a sharp increase in food prices.

The Current Account Deficit (CAD) moderated to 3.6% of GDP in Q4FY13 of 2012-13, down from 6.5% in Q3FY13, due to a narrowing of the trade deficit. However, if we assess for the fiscal year 2012-13 as a whole, it is at record high f 4.5% (at U.S. $87.8 billion) - much over the central bank's comfort level of 2.5% of GDP. Moreover now weakness in rupee is adding to the worry over CAD.

Speaking about liquidity situation, it has eased considerably since May policy. The average daily net liquidity injection under the liquidity adjustment facility (LAF) declined to Rs 828 billion during Q1FY14 from Rs 1,078 billion during Q4FY13.

Monetary Policy Action...
Thus in the background of the aforementioned macroeconomic situation and to balance risks thereto, it was decided by RBI as under:
 

• To keep the repo rate unchanged at 7.25%; and
• To keep the reverse repo rate unchanged at 6.25%
   

Thereby, maintaining the Liquidity Adjustment Facility (LAF) corridor between repo and reverse repo rate at 100 basis. The Marginal Standing Facility (MSF) rate stands unchanged at 300 basis points (bps) above the repo rate at 10.25%, as per last measure taken by RBI on July 15, 2013 to contain the rupee. Likewise the bank rate which is adjusted in congruence to MSF also stands at 10.25%.

However, since CRR was already reduced by 200 bps since January 2012 to infuse liquidity and active management of liquidity vide Open Market Operations (OMOs) have also taken place, the CRR was kept unchanged at the current level of 4.0% of banks' Net Demand and Time Liabilities (NDTL).

  Policy rate tracker

	Increase / (Decrease) since FY12-13	At present
Repo Rate	(125 bps)	7.25%
Reverse Repo Rate	(125 bps)	6.25%
Cash Reserve Ratio	(75 bps)	4.00%
Statutory Liquidity Ratio	(100 bps)	23.00%
Bank Rate	100 bps	10.25%

Data as on July 30, 2013
(Source: RBI, PersonalFN Research)  

What does the policy stance mean and its impact?

The repo rate is the rate of interest charged by the central bank on borrowings by the commercial banks. Keeping it unchanged would infer, borrowing cost of commercial banks may remain same. Hence as a reaction to such a move, cost of borrowing for individuals and corporates may also not ease thereby home loans and car loans being available at the same rate as present.

The reverse repo rate is the rate of interest, at which the banks park their surplus money with the central bank. Keeping it unchanged will imply that commercial banks would fetch the same interest rate as they are receiving at present, for parking their surplus funds with RBI.

The Cash Reserve Ratio is the amount of liquid cash which the banks are supposed to maintain with RBI. Keeping it unchanged, will not infuse further primary liquidity into the banking system. As per the move from the RBI on July 23, 2013 in order contract liquidity to contain the rupee, banks are asked to maintain Cash Reserve Ratio (CRR) of 99% (of 4% i.e. about 3.96%) with effect from July 27, 2013 on daily basis as against the earlier minimum requirement of 70%.

The Statutory Liquid Ratio (SLR) is the amount that the commercial banks require to maintain in the form of cash, or gold or Govt. approved securities before providing credit to the customers. Keeping it unchanged at the last reduced level of 23.00% could help credit flow in the system - especially to productive sectors, which could be address growth risk.

It is noteworthy that according to the RBI, stance of the monetary policy is intended to:
 

• Address risk to macroeconomic stability from external shocks;
• Continue to address heightened risk of growth;
• Guard against re-emergence of inflation pressure; and
• Manage liquidity conditions to ensure adequate credit flow to the productive sectors of the economy
   

Guidance from monetary policy and path for interest rates:
 

The monetary policy stance over the last two years has predominantly been shaped by the growth-inflation dynamic even as external sector concerns have had a growing influence on policy calibration over the last one year. The current situation - moderating wholesale price inflation, prospects of softening of food inflation consequent on a robust monsoon and decelerating growth - would have provided a reasonable case for continuing on the easing stance. However, India is currently caught in a classic 'impossible trinity' trilemma whereby we are having to forfeit some monetary policy discretion to address external sector concerns. The recent liquidity tightening measures by the Reserve Bank are aimed at checking undue volatility in the foreign exchange market and will be rolled back in a calibrated manner as stability is restored to the foreign exchange market, enabling monetary policy to revert to supporting growth with continuing vigil on inflation. It should be emphasised that the time available now should be used with alacrity to institute structural measures to bring the CAD down to sustainable levels. The Reserve Bank stands ready to use all available instruments and measures at its command to respond proactively and swiftly to any adverse development.

Outlook on domestic economic growth and inflation:
The RBI in its May policy projected GDP growth rate for fiscal year 2013-14 at 5.7%, conditional to normal monsoon (leading to agriculture growth). The outlook for the industrial activity was expected to remain subdued (which indeed it has turnout to be) and so was sluggishness in services expected. The activity, both in domestic and global, has evolved in line with these expectations. While the progress of the monsoon has been good thus far, industrial activity on the other hand has heightened the risk to growth. Moreover, global growth has been tepid, with some signs of loss of momentum in the U.S. and in EDEs on top of the on-going contraction in the euro zone. This has impacted world trade with consequent adverse spill overs on India's exports, manufacturing and services. Over the last one year, the Government has taken several policy initiatives to improve the investment environment. As these initiatives work through the system and are further built upon, the current slowdown could be reversed, returning the economy to a higher growth trajectory. On the basis of the above considerations, the growth projection for 2013-14 is revised downwards from 5.7% to 5.5%.

On inflation, in the May Policy, the Reserve Bank indicated that during 2013-14, WPI inflation will be range-bound around 5.5%, with some edging down in the first half and some increase in the second half, mainly on base effects. During Q1FY14, the inflation trajectory has moved largely in line with these expectations, although some risks to the path of inflation have surfaced in June. The stronger than expected monsoon has not yet softened food inflation as much as it should have. In particular, vegetable prices have been impacted by weather-driven supply disruptions. While the outlook for global non-oil commodity prices remains benign, international crude oil prices are firming up. This is reflected in an upward adjustment of domestic prices of petroleum products, besides the programmed revisions in diesel prices. The sharp depreciation of the rupee since mid-May is expected to pass through in the months ahead to domestic fuel inflation as well as to non-food manufactured products inflation through its import content. The timing and magnitude of the remaining administered price revisions are a source of uncertainty for the inflation outlook. Keeping in view the domestic demand-supply balance, the outlook for global commodity prices, and on the expectation that spatial and temporal distribution of the monsoon during the rest of the season will be normal, the Reserve Bank will endeavour to condition the evolution of inflation to a level of 5.0% by March 2014, using all instruments at its command. It is noteworthy that objective is to contain headline WPI inflation at around 5.0% in the short-term, and 3.0% over the medium-term, consistent with India's broader integration into the global economy.

What strategy should debt investors should adopt?

As seen above, in the guidance from monetary policy the RBI has mentioned that India is currently caught in a classic 'impossible trinity' trilemma, where the risk emanates from external sector concerns, volatility in foreign exchange and CAD. Moreover, the investment climate remains weak and risk aversion continues. In such a scenario, the central bank stands all ready to use all available instruments and measures at its command to respond proactively and swiftly to any adverse development.

The measure of hiking short-term rates and liquidity contraction taken in the recent past (intended to contain the rupee), brought in volatility in the Indian debt markets; where duration funds and gilt funds have witnessed rather a violent fall in their NAVs thereby impacting their returns as a result of ascending yields. Going forward too, longer maturity papers would remain under pressure until the aforesaid risks are in play.

PersonalFN is of the view that, it would be best to refrain investing in longer maturity debt papers in the aforesaid backdrop, and instead prefer shorter maturity debt papers. If permitted by your time horizon and risk appetite if you still want to invest in long-term debt funds, it would be wise to take exposure via dynamic bond funds (as enabled by their mandate they hold debt instruments across maturities). But PersonalFN thinks that given the aforementioned interest scenario and macroeconomic variables thereto, one should not hold more than 20% of their debt portfolio in longer tenure funds. Avoid investing in G-sec funds , as they may see high volatility and may not be an ideal instrument to yield fruitful returns. Fixed Maturity Plans (FMPs) of 3 months to 1 year period can also be considered as an option to bank FDs only if you are willing to hold it till maturity. Alternatively you can also invest in 1 year Fixed Deposits (FDs), as banks are offering interest on 1 year FDs in the range of 7.00% - 8.75% p.a.

In the present scenario, it would be ideal to invest in shorter duration instruments vide debt mutual fund schemes having shorter maturity profile. Investors with an extreme short-term time horizon (of less than 3 months) would be better-off investing in liquid funds for the next 1 month, or liquid plus funds for next 3 to 6 months horizon.

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jujhtbex@yahoo.com Mar 17, 2014 I've learned sreveal important things through your post. I will also like to express that there can be situation in which you will apply for a loan and do not need a cosigner such as a Federal government Student Aid Loan. However, if you are getting financing through a traditional loan service then you need to be ready to have a cosigner ready to allow you to. The lenders will probably base their own decision over a few components but the main one will be your credit history. There are some lenders that will additionally look at your work history and make a decision based on this but in most cases it will hinge on your report.

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