Looking ahead to the Apr’12 RBI Policy

Now that the February’2012 and January’2012 revised IIP numbers and the March’12 Inflation numbers are out the attention turns to the RBI policy on the 17^th of April. As per Government data inflation is still stubbornly high at 6.9%.Notably food inflation is still very high at around 9.9%. February IIP growth came in at 4.1%.The very high inflation numbers under normal circumstances would not have allowed Mr. Subbarao to decrease CRR or the reverse repo rates. But these are not normal times are they?

Before diving into the pros and cons of a bank rate cut let us take a look at the Current Account situation.

The Current Account deficit has worried the Finance Minister so much that he had to raise the customs duty on gold. The merits of such a move are debatable. On the other hand with the Indian Rupee currently trading at around 51.30 to the US dollar means imported crude (80% of India’s crude oil is imported) has become more expensive apart from the fact that crude has at an average traded at $120 to a barrel (Brent crude) consistently in 2012.A growing current account deficit and erosion of our foreign exchange reserves is a worrying factor. If you reduce the bank rate and if it has a negative impact on inflation – which it might well have it would mean that the value of the rupee goes down further, this would mean that the rupee depreciates further against the dollar making crude oil imports even more expensive. This would in turn drive up inflation.

The government has till now shied away from increasing the administered price of fuel, but will not be able to hold on any longer. Oil Marketing companies are bleeding. Raising fuel prices is a double edged sword. On one hand by reducing subsidies it will help the Government to tide over the fiscal mess it has got itself into on the other hand, however, raising prices by reducing the Government subsidy will lead to higher inflation. Petroleum products are the highest taxed goods in India. Yet some of the petroleum products are also subsidised. An anomaly which is difficult to explain. To put it simply the taxes go into the Government coffers while on the other hand a large part of the subsidies are borne by Listed Government Companies. The Government does compensate the oil marketing companies but not 100%.

A further depreciation in the rupee would make things even worse.

A weaker rupee will make exports cheaper but the rise in input cost by way of rise in fuel would ensure that margins for exporters remain under pressure.

Further depreciation of the rupee would also make debt servicing by the Indian Government and the corporate sector more expensive. As an example if the Government had borrowed $10 billion dollars when the exchange rate was Rs48 for 1 dollar it had effectively borrowed Rs 48,000 crores. Now the rupee being 51.30 to a dollar means that the government will have to effectively pay Rs 51,300 crores in rupee terms an increase of 3,300 crores in around 6 months…..

It is against this back drop that Mr. Subbarao has to make the decision whether or not to cut CRR or the repo rate.

In terms of pure economics it is difficult to see Mr. Subbarao cutting rates. He has my support if he decides to remain firm and firm he must remain.

Thanks to the incompetent finance minister our “khazana” is near empty.

Privatisation of PSU’s have gone nowhere. Depending on LIC to bail out failed FPO’s or IPO’s will not work for ever. Spectrum auction should be seen as a one off receipt, expected to rake in Rs40,000 crore in FY’13 he must use it to reduce Government Debt instead of financing Air India and HMT restructuring.

On last count it is estimated that the Government will borrow Rs3,70,000 crores from the market in the next six months.

This will crowd out the market of liquidity and raise the borrowing cost of companies. Unless there is concrete action on the ground by the Government to reduce the budget deficit and rein in inflation the RBI Governor should not budge. The RBI has so far resisted pressure from the market to cut rates materially. This is a wise decision. Inflation has not gone down, infact food inflation has  alarmingly gone up. Higher excise and service tax post budget would have a negative impact on inflation.This was done by the Finance Minister not the RBI. The RBI must not be held accountable for the follies of the Finance Minister.

 Inflation in India is more a supply side phenomenon than a demand side. This means that the supply of goods and services has stagnated rather than the demand for them have quantitatively increased. If you decrease the bank rate what it will do is make borrowing cheaper for companies. This will make them invest to increase production which will increase supply of goods and services and this in turn will lead to lowering of prices. So much for the text book knowledge. India’s inflation is driven by increase in food  and fuel prices and soon to be -  rise in excise and service taxes. Rise in food prices unfortunately has to do more with black marketing, hoarding ,archaic laws and inefficient supply chain rather than pure economics. Hence if we want to see an increase in the supply of veggies ,pulses, cereals ,fruits and protein to the market tinkering with the  bank rate will be of little use. What experts and commentators also miss out is that large Indian companies have huge cash and cash equivalent lying in their balance sheet, why would they then go in for market borrowings?

The moderate IIP numbers and the slowdown in the economy seems to be be attributed to the very high interest rates. Although interest rates do play a very important role in the growth of the economy, what is required now is heavy doses of sensible economic reforms.Bank rate’s by their own can not change the course of India’s slowing economy. Without pragmatic economic policies backed up by implementation it will be difficult to increase the economic growth rate and rein in inflation.

The tone of the RBI’s post policy notes clearly places the ball in the Government’s court to rein in inflation by reducing the budget deficit. At best tomorrow’s RBI policy will lead to a reduction in the repo rates by 25 bps.Let us see what is in store for us.

Deciphering the Feb’12 IIP numbers – Jan’12 IIP numbers revised down

As a shocking admission of the slowdown in the Indian economy the Jan’12   IIP numbers were revised down from …..hang on…. from a high 6.8% to 1.1%.The Finance Minister was quick to quote his “unacceptable” remark again. Remember that this is the same gentlemen who goes on stating the high inflation numbers as being “unacceptable” for the last one year. Apparently the blame is being laid on the doors of the Directorate of Sugar (yeah we even have a separate department for that) for incorrectly stating that the sugar production at 13.4 Million tonnes instead of the actual (for the time being) 5.9 Million Tonnes.

The poor guy seems to have lost his calculator on his way to office and had to depend on the abacus to do his calculations.

Let us look at the more respectable and “acceptable” Feb’12 IIP numbers which came in at 4.1%.Well at least till they are revised downwards in the subsequent months. Manufacturing grew at 4%, electricity at 8%,mining sector grew at a respectable 2.1%,Capital goods grew at 10% while consumer goods contracted at 0.3%.Lets try and decipher these numbers .The first assumption being that the numbers reported by the CSO (Central Statistical Organisation) is correct. That assumption being made let us looks at the capital goods growth numbers for starters. After months of negative growth the capital goods numbers have grown at 10%.This had to happen. Apart from growing from a lower base it is important to note that the Indian economy in spite of slowing down is still growing at around 6%, considering that our GDP is at around $1.8Trillion it means that we are adding around $108 Billion to our GDP this year. This means that aggregate demand for goods and services has grown and will continue to grow at a moderate rate in the near future. This in turn would mean higher production of capital goods which basically is required to produce consumption goods.

Electricity growth numbers are good. The Indian economy cannot grow at a sustained high rate unless there is quality supply of adequate electricity. In fact India is one of the few very big economies where the aggregate demand for goods and services will grow and the only limiting factor for GDP growth rate would be the lack of quality infrastructure. Growth in India would be constrained by supply rather than demand. This is in stark contrast to the developed world where the limiting factor to economic growth is net aggregate demand and not supply. The challenges ahead remain; electricity consumption would peak in the hot summer months when air conditioners are turned on and the harvesting and sowing season kicks in. Since electricity in India is still thermal based the mining sector “read” coal has to pick up to ensure uninterrupted of coal to the power producers. Controversial (FSA) agreement between the Government  owned monopoly Coal India and power producers must be ironed out as soon as possible. Signing of the FSA has already been delayed .The initial 31^st March deadline it has extended to mid April. Delay’s in getting environmental clearance, political issues and land acquisition issues has ensured that Coal India would be unable to meet the industrial requirement for coal. This would mean that India which has one of the largest proven reserves of coal would have to import coal from Australia and Indonesia. Cost of imported coal being higher (unlike in the pricing of Coal by Coal India the Government of India has no political influence on the pricing of imported coal) this would result in electricity cost going up. The resultant increase in the cost of production would lead to higher prices and higher inflation.

The contraction in consumer durable numbers should not raise any alarm bells ,yet. Unlike the US we are still not a consumption based economy. Individual house holds still have a high savings rate. This is good. We need to save to invest in our future ,our and our future generations. However, a prolonged drop in consumer durables  demand would lead to lower factory orders ( doubtful in India’s case) which would then lead to job losses and lower indirect tax revenues for the government. This could in a dooms day scenario send the economy into an unrecoverable tail spin. This as I mentioned remains doubtful. One the Indian economy is still underdeveloped which means that demand for basic consumer durable will remain as ownership/penetration remains low , second with our high savings rate individual house hold can divert a part of their savings to consumption and thirdly consumer demand is cyclical where after completing its lifecycle a product has to be replaced or replenished.

Also remember that capital goods are used to manufacture consumer goods and since capital goods have seen a health growth rate it would mean that producers of consumer goods have budgeted for an increase in consumer good consumption in the medium term while placing their orders for capital goods.

 Next week the spotlight switches over to the inflation number and the all important RBI meeting.

Let us see what Mr. Subbarao has in store for us.

Investing for your retirement - Part 1

Investing for your retirement

Building up your Nest Eggs -

Now that Finance Minister has spoken and the post budget speeches by all have been done away with, I turn my attention to more “serious” things to consider. Unlike other commentators I will not indulge in useless and unproductive bashing of the finance minister. For that you can tune into the television channels of your choice where “paid” speakers provide their valuable personal feedback on the budget.

I am trying to find out the ways and means by way I am able to save up and invest for my retirement apart from saving up for  my children’s education and their marriage. Building up your nest egg’s or in layman’s term your post retirement funds is extremely important. Unfortunately I rarely find any erudite person on paid television or in the newspaper guiding me to do so. So being a professional let me start by helping myself.

Let me look at it by jotting down a few points.

1.       Start saving now –

It is imperative for us to start saving now.

This has various advantages. Apart from the benefits of compounding it would mean that if we can spread our total investments over a longer period of time, the contribution in a given year would be a lot lower to attain a specific target than if the contribution was spread over a limited time frame. This coupled with compounded interest which is provided by EPF (Employee Provident Fund), PPF (Public Provident Fund) and even Bank FD’s (Fixed Deposit’s) ensure that we are able to save a lot more if we start to save a lot earlier.

As an example Rs 20,000 invested for 20 years in a PPF (PPF term can be rolled over for additional 5 years after the completion of 15 years) will fetch you around 10 lakh at the end of 20 years.

On  the other hand if you start late and can invest Rs20,000 for 15 years only at the end of 15 years you will get a return of around Rs 6 lakh.

Rate of return in both cases at 8.6%.(not adjusted for inflation and tax benefit).

This is the power of compounding.

2. Do not put all your eggs in one basket   -Diversify your investments.

As a salaried employee 24% of my basic salary is “forced” saved into a Provident Fund account. This would give me returns of 8.25% for the year 2011-12, certainly much lower than the rate of inflation in India even if you consider that contributions are tax exempted giving a real rate of return of around 10.7% (assuming we are in 30% tax bracket) .

As a individual you can also open up a PPF (Public Provident Fund) separate from EPF with either the State Bank of India or in the Post office. Interest in PPF is at around 8.6% and like EPF contributions are eligible for tax benefits. However, you need to note that although the rate of interest is stable they are no ways fixed. The Government in fact has reduced the rate of interest on EPF from 9.5% for the year 2010-11 to 8.25% for the year 2011-12.Till now payouts at the time of retirement from both EPF and PPF are exempted from tax. This might change with the advent of the DTC (Direct Tax Code) under the EET (Exempt Exempt Tax) model. In a PPF in the State Bank of India a person can invest a maximum of Rs70,000/-. While EPF is “forced” on salaried individual PPF is voluntary and open to all.

However, for the purpose of claiming deduction under section 80C both are clubbed to compute the maximum deductible amount of Rs 1 lakh ( NSC, Insurance, Principal portion of EMI ,fixed deposits are also eligible,).

Since both PPF and EPF provide similar rates of return it is important to look at other investment option as well.

Insurance Policies of late have become a favourite of investors because they offer insurance along with returns other than the fact that it can be claimed as a deduction under section 80C.

However, the rate of return on insurance is very low .Most Indians would look at investing in LIC ( which in turns look s to bail out the Government example being the ONGC FPO issue in mar’12 ) which gives a rate of return of around 6%.( I am referring to endowment policy and not ULIP’s)

ULIP’s or Unit Linked Insurance Policy are Insurance Policies’ where the money invested by the investor is invested into either the stock market or the debt market (depending on the choice of the investor) and offers insurance as well. I have never been a fan of ULIP’s if you want to invest in the stock markets or Mutual fund or the debt market then you can do it on your own by careful research and reading the financial statement and performance of the MF or the company. There is no need to pay exorbitant management fees to fund manager. The greater risk lies in the fact that today most people look at investing in ULIP’s as a way to invest in the stock markets. Those that had invested prior to the Lehman Brothers crisis have suffered, the resultant crash in the stock markets post the Lehman brothers crisis  have reduced the value of units considerably and offer returns lower than Bank FD’s. Those who had parked their lifelong savings in ULIP’s as a retirement option have had their fingers burned.

I would be looking at picking up a simple vanilla “term” policy. A term policy unlike endowment or money back policy is purely insurance policy with no returns. It is meant to cover for your life and not an investment option. Since I already have an endowment policy with life cover with LIC the next insurance policy would be a “term” one. Term policies also have much lower insurance premium than an endowment policy and the money saved can be invested in an instrument or asset class which gives me more than 6% of returns.

Invest a certain portion of your retirement portfolio in gold. It is important to note that when I talk about investing in gold I am talking about holding physical gold and not the paper or electronic form.

The rate of return of gold as stated in my previous topic is certainly at par if not much better than that offered by other savings instruments.

Saving towards buying an apartment of our own is both an investment as well as a sound retirement goal. Ensure that you do not have any EMI’s still pending when you retire. In fact you should have cleared off all your EMI’s whether related to property, car, your children’s education well before your retirement.

If you are lucky to be earning and saving enough to go in for a second apartment after calculating the amount required for your child’s education and marriage and setting aside money for an emergency fund ensure that the apartment is in a city where you want to live your retired life. It might not be in a city where you are currently working. A second property is a very good investment option. You can get a steady source of income by renting it out or after selling the property you can invest the sale proceeds in a fixed deposit earning fixed rate of returns.

3. Put aside a part of your net take home for retirement –

Start saving up now for your retirement. Set aside a portion of your net take home (salary less deductions like tax, contribution to provident fund etc) to build up your war chest for retirement. DO NOT TOUCH IT. Start with an achievable number let us say 5% each month for 4 months and then increase it to 10%.If you can save more than that, that is great !Ensure that you do not add this number to existing retirement savings that you already do. (So do not consider any LIC premium or EPF contribution that you are doing already) .Believe me the way inflation is these days we will need every rupee for our retirement. If you buy gold or put it in a FD or PPF just please forget about it(meaning do not look to disinvest out of it). Unlike the stock markets these instruments and asset classes provide relatively stable and risk free returns and you do not need to check their returns daily. Saving an additional 10% for your retirement should not be difficult. As a salaried person I contribute 24% of my basic salary to a EPF account hence I should be able afford another 10% to be saved additionally for my retirement. In case you are not a salaried individual I advise you to set aside at least 25% of your net take home for investing for your retirement. Only for retirement.

Invest a part of your bonus or any additional receipts that you might get into a NSC or a long term Fixed Deposit. The best thing about an NSC or FD is that it has a lock in period for the investment. It would be difficult to disinvest in before the tenure of investment is over. Unlike PPF which has a fixed 15 year terms you can invest in an NSC in different denominations.NSC have a fixed period of 5 years reduced from earlier 6 year period. An amount of Rs 10,000 invested today will give you around Rs 15,000 after 5 years time and you will not be able to break that investment in between. On the other hand if you invest in a PPF fund today then you will only be able to receive the investment proceeds after 15 years. (Partial with drawl is allowed after 5 years)

Part 2 follows soon……