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equity or debt where to invest now

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equity versus debtRBI has been instrumental as India’s Central Bank in framing various monetary policies to balance the economy – be it to tame inflation or to boost growth or to control weakening of currency. Of late, the broad consensus amongst market participants was that with inflation in RBI’s comfort zone (<6%) and growth tapering off (IIP being negative, GDP <5%), there would be a series of rate cuts from the Central Bank. This theory panned out for the early part of the year where RBI took a series of repo rate cuts. However, post US economy picking up and with US Fed comments on tapering off their QE program, the global funds went into a distinctly risk off mode, thereby cashing out from emerging markets, of which India is a subset. We saw debt out flows to the tune of $5.2bn last month. As a result of weak macros plus the aforesaid, rupee really took a tumble and depreciated ~15% in a matter of a few weeks.

Hence, RBI came in last week and took some steps to tighten liquidity and reduce speculation for rupee. This was a “disguised” rate hike. They reduced limit for borrowing under Liquidity Adjustment Facility (LAF) to Rs75,000cr (earlier no limit, was nearly 1,50,000cr at times) and they also hiked Marginal Standing Facility (MSF) rate by 200bps (Repo +300 so it is 10.25% from 8.25%).It also announced an Open Market Operations (OMO) sale of Rs. 12,000cr to suck out liquidity. After a few days, they made hawkish moves by further reducing LAF limit for banks to ~Rs35,000cr (0.5% NDTL) and limit on CRR was moved from 70% to 99%. All these moves make borrowing expensive and suck out liquidity from the system.

These steps were not anticipated and RBI seems hawkish now with aim to control currency risk and control CAD/Inflation. The implications for equity markets are negative for short term since it implies higher cost of borrowing and lack of rate cuts, thus impacting rate sensitive sectors like banking, auto, capital goods and construction. This theory played out with banks and capital goods getting hammered in the previous week. Safe sectors like FMCG, IT and Pharma saw already expensive stocks in them like Unilever, Dabur, ITC, TCS, Glenmark, Dr Reddy etc. getting further expensive.

What should you do?

An astute investor should use this opportunity to book profits in richer sectors and pick decent blue chips at lower prices. A lot of quality private sector banks, capital goods companies are available at a reasonable valuation. We can seek comfort from the fact that the actions taken by the RBI can be undone overnight and if RBI feels, it may unwind these measures over the next quarter. So action point for

Equity long term investors

should be to pick up large cap blue chip banking stocks like HDFC Bank, ICICI Bank, Yes Bank, SBI, BoB and some premier capital goods like Larsen & Toubro, Cummins etc. Some other stocks in power, construction, cement also look interesting. These stocks should hold investors in good stead over next 12-18 months.

For debt, both liquid and income funds are expected to see negative returns for the short term. AMFI already marked down liquid funds to reflect these rate moves and even liquid funds should see negative returns in immediate horizon. Long duration funds could be a good investment. The 10Y GSec yield is now at ~8%+, with Corporate yields at ~9.5%. The overall interest rates should trend downwards over next 12 months i.e. with slower growth; RBI may eventually unwind these measures and initiate rate cuts. This will help the investors with mark to market gains. The next 30-40 days may be pretty volatile for debt markets. But the move should clearly be towards Long term Income funds. Existing debt investors should not panic and remain invested. Eventually once the dust settles, investors in debt market for 1-2 year time frame can expect ~10% p.a. kind of returns.

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