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Options to Invest in the Slowing Indian Economy
January 31, 2011

Tight liquidity combined with high and rising interest rates are affecting India's industrial productivity and corporate profitability, and thus the GDP growth rate. FSM provides an update and outlines the best avenues for your money in this scenario.

Author : Manjunath Gaddi

Untitled Document         

Highlights of RBI Monetary Policy Review for third quarter of the financial year 2010-11

  • Repo rate increased by 25 basis points (bps) from 6.25% to 6.50% with immediate effect
  • Reverse repo rate increased by 25 bps from 5.25% to 5.50% with immediate effect
  • The Cash Reserve Ratio (CRR) and the Bank rate retained at 6.00%
  • The target Wholesale Price Index (WPI) Inflation for March 2011 has been raised to 7% from 5.50%
  • The RBI expects the Current Account Deficit (CAD) for FY2010-11 to be at 3.50% of the GDP
  • The GDP growth for FY2010-11 is being retained at 8.50% with upward bias
  • Liquidity remains tight in the economy. The credit growth (Y-o-Y) as at December end has gone up to 24% as against the RBI’s projection of 20% whereas, the Money Supply growth as at December end is at 16.50% against the RBI’s projection of 17%
  • FIIs withdrawing money for the markets has led to the equity markets losing around 7.60% in January. More correction is expected if US shows positive signs
  • Liquidity deficit and rising rates make debt market attractive

RBI’s Third Quarter Monetary Policy Review

The RBI in its third quarter monetary policy review increased the Repo and Reverse Repo rates by 25 basis points to 6.50% and 5.50% (One basis point is one hundredth of a percentage).  The hike in the rates was expected as soon as the WPI inflation for December 2010 rose to 8.43% from 7.48% in November 2010. The RBI chose not to hike rates in the mid-quarter policy meet held in December as inflation fell to 7.48% in November from 8.58% in October.

There has been no change in the other policy rates, the CRR, (Statutory Liquidity Ratio) SLR and Bank rates have been kept at 6.0%, 24% and 6.0%. Chart 1 highlights the rate hikes that RBI has undertaken since 2010.

Slowing Economic Growth

The RBI has increased the Repo and Reverse Repo rates seven times since March 2010.  All these rate hikes have started showing their effect on the industrial production. The industrial production growth, apart from becoming more volatile in the past few months, fell to 2.70% in November from 10.80% in October. November’s numbers are the lowest in the current financial year.

Chart 1: Policy Rate Hikes 

Also, despite a strong GDP growth of 8.90% in the first half of FY2010-11, the RBI has not revised its GDP growth projection. The RBI’s refusal to increase the GDP growth projections can mean that the rate hikes might affect the growth of Q3 and Q4 2010-11 harder than anticipated.

The non-food credit growth as of December end was at 24%, higher than RBI’s projection of 20% while the Deposit growth was at 16.5% against the RBI’s projection of 17%. The deposit growth in October first week was 15.20%; with banks offering higher rates on fixed deposits in December, the deposit growth grew to 16.50%. The banks will have to pass on the higher rates on deposits to the borrowers; this will increase the borrowing costs for the corporate sector which will reduce the profitability of companies.

Equity Market Reactions

The SENSEX fell by 182 points to close at 18969.45 points on 25 January despite good quarterly results from many companies. The SENSEX is trading at a 1 year forward PE of 19.04X as of 25 January. Although the PE is below 20X as seen in the past few months, it is still over valued as compared to it long term average of 17X.

The SENSEX has performed negatively in January by losing 7.60% (as at 25 January) despite good quarterly numbers. This is due to FIIs redeeming their investments. From January 1 to January 24, the FIIs have withdrawn over US$849 Million from the equity market. The outflows may continue if US shows positive signs of growth. So, in the short term some correction can be expected. This will provide the right opportunity for investors to start their investments into equities.

Debt Market Reactions

The 10 year Government Security yield continues to be in excess of 8.10%. The rate hikes by RBI and the continuing liquidity deficit situation will make the debt sector more attractive to domestic and international investors.

The banks are increasing their fixed deposit rates due to the liquidity deficit situation in the system and many mutual fund houses are launching many Fixed Maturity Plans (FMPs) to help investors to get better returns in comparison to fixed deposits.

FSM’s Recommended Investments in such a Market

Investors who continue to sit on idle cash in your savings bank account can consider investing into Ultra Short term funds with dividend option, as the tight liquidity situation will yield more returns than the 3.50% on your savings account. Investors can consider investing into Birla Sun-life Ultra short term Fund and BNP Paribas Money Plus Fund.

  • Investors with 6 to 9 months time horizon can invest in short-term funds because the liquidity situation is expected to remain tight in the short term. Investors can  consider investing into  Reliance Short Term Fund and Templeton India Short Term Fund.
  • Investors having a 3 to 24 months time horizon can invest in FMPs as it is a good time to lock-in yield at the current high levels. To invest in FMPs  click here.


iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.


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