After the demonetisation decision in mid-November was not followed by an immediate reduction in rates, expectations had built for a 25bps cut in the February meeting. There were questions with regards to the independence of the RBI following perceived weakness in handling the impact of demonetisation.
But the Monetary Policy Committee of the Reserve Bank of India (RBI) chose to keep rates on hold at their meeting on 8 February with all members voting to maintain the status quo. This decision to keep rates on hold has pushed back against those doubters. However, it will now lead to people seeking to understand the implications of a shift from the RBI’s accommodative stance of the past two years to a more neutral position.
The Union Budget at the outset of the month laid out plans for the government to stick to its fiscal discipline while enhancing areas of spending, which had led most to believe a rate cut would be forthcoming. Fiscal strength is good news for the bond markets, however the expected increase in the issuance of long-dated securities by state governments, and the central government’s intention to enlarge its bond buy-back programme, risks steepening the yield curve in 2017.
The shift to a neutral stance, and the possible end of rate cuts for the medium term, is aligned to the inflation target of 5 per cent for end of March 2017, and setting expectations for 4 per cent one year later. In its announcement, the RBI highlight their concerns that the consumer price index inflation could rebound from the excessively low counters seen in November and December. Consumer demand is expected to snap back following the liquidity squeeze created by the demonetisation fallout and with rising energy prices, inflationary pressures are expected to resurface.
The Central Statistics Office released its data on India’s growth forecasts with the full year to March 2017 expected to show GDP growth at 7 per cent, down from initial expectations of 7.8 per cent, largely due once again to demonetisation. The strong monsoon of 2016, allied to the implementation of the 7th Pay Commission increase of civil service salaries, all point to inflationary factors in the domestic economy – sectors to which the Ashburton India Equity Opportunities fund is aligned. Export growth for India was also noted as being positive in the minutes from the RBI meeting, which continues to add support to the stable Indian rupee.
What does all this mean for growth expectations moving forwards? The RBI stated in their reports that they see a strong recovery in growth in the coming year to March 2018. Firstly, discretionary demand, restricted in the weeks following demonetisation, will return while sectors more reliant on cash transactions such as retail trade, hospitality and transport should show a sharp rebound.
Finally, the RBI are noting the improvement in bank funding conditions as affordability of loans and consumer financing has stepped up in recent weeks. Add into the mix the supportive Union Budget and the “setback” of an expected rate cut looks less of an impact on sentiment than at first look. In the following month, five state elections are taking place with results due mid-March. Prime Minister Modi will be hoping for a strong showing in the polls to set his path towards re-election in 2019.
For bonds, the initial reaction was naturally for a spike in bond yields. The 10-year G-Sec yields rose 30bps to 6.7 per cent, rebounding from the 10bps reduction at the end of January as US Treasury yields rose. Corporate bonds are likely to follow suit which should assist banks to regain lost market share in loans as people move away from the local bond market. With deposit rate reduction transmission completed, banks may also reduce their deposit and savings rates to ease any margin squeeze moving forwards.
The Ashburton India Equity Opportunities fund remains closely aligned to the government’s investment path; infrastructure, reform within the banking sector and decisions to support an uplift in consumer spending. Our overweight positions in industrials, financials, and consumer discretionary stocks, while our underweight to staples, a sector we see as excessively overvalued, has been long-standing in the Fund.
Both the fixed income and equity markets of India remain core to Ashburton Investments’ strategy. India remains the fastest growing major economy, supported by a youthful and entrepreneurial demographic, enabled by a reform-minded government, with strong corporate governance credentials and a Prime Minister intent on driving India to success.
Simon Finch is co-manager of the Ashburton India Equity Opportunities fund at Ashburton Investments.