Is it a party time after rate cuts by RBI??

After 13 continuous spells of rate hikes and two consecutive CRR cuts RBI finally did a cut in Repo and reverse repo rate by 50 basis points. Current Repo rate stands at 8% and Reverse repo rate at 7%. RBI started hiking rates from March 2010 to control inflation which has been hurting the Indian economy like a monster. In simple economic terms rate hike was supposed to make availability of loans difficult thereby curtailing liquidity and dampening the growth which in turn would reduce the demand leading to reduction in prices followed by a lower inflation. The strategy was to control inflation by taking a hit on growth which had slowed down drastically to 6.1%. The IIP for January 2012 dropped to an all time low of 1.1%. The massive liquidity crunch led to a rally in the CD rates (1 and 3 months) which crossed 10.5% mark. Heavy borrowing by Government to finance the burgeoning fiscal deficit added to the problem. Yields of 10 yr G-sec’s soared to 8.75% and speculations were rife that the soaring liquidity crunch would take the 10 yr G-sec’s to 9%. RBI did two CRR cuts to infuse immediate liquidity in the system and bring some respite. But the crunch was to such an extent that the money infused in the system got used with just a blink of an eye. The RBI Governor finally took the most awaited step of cutting down the rate.
However this rate cut doesn’t seem to bring cheers to the slowing Indian Economy. Some reasons which could spoil the party: 

- Banks do not seem to be cutting down rates immediately. Banking sector as such is reeling under heavy NPA pressure. Any lowering in rates means taking a hit on NIM’s. Also the deposit rates would be required to cut which might have an adverse affect as Banks are finding it hard to mobilize the deposits. Hence most of the Banks maintained a status quo in their base rate with some banks doing a nominal base rate cut.

- Inflation (WPI) although came down to 6.89% levels before RBI cutting the rates, the pressure still continues to be on as Food prices still do not seem to moderate. Supply chain problem remains a critical problem which continues to go unaddressed by the government.

- High level of Crude price is keeping the inflation pressure on. Also demand by Oil companies to the Government for enhancing Oil Prices could play the spoilsport. Oil marketing companies are already reeling under heavy under recoveries and are consistently demanding the permission to hike oil prices from the government. Deregulation of diesel also continues to be a mooted topic. Any negative step at this end will have severe impact down the line on inflation and growth. Crude prices are currently hovering at $120 per barrel mark whereas the growth calculations in the Fiscal Budget 2012-12 have been done assuming the crude price level of $115 per barrel.

- High fiscal deficit remains another major issue. This will lead to heavier Govt Borrowing thus keeping pressure on liquidity and yields. 10 Year G-sec Yields which went down to 8.30% after announcement of rate cut by RBI has again bounced back to 8.6 levels.

- Rupee continues to slide against the dollar keeping pressure on trade finance activities and growth. Any fall in rates will discourage the foreign investors who are already shying away from India. NRE deposit rates are at all time high of 9%+ levels to encourage dollar flow and stabilize the value of rupee.

- Slow reforms by the Govt have raised concerns about the growth of Indian Economy among the investor fraternity. Insurance, Retail FDI, Aviation, etc bills are still in limbo and no reform signals available at governments end.

RBI will have to balance between growth and inflation and take a call on its further course of action. High growth leads to high inflation whereas low growth has its own set of problems. Time will tell whether it will be cheers or tears for Economy and the common man.

What hinders retail investment in Equity Funds?

Investment in Equity Mutual Funds in volatile or falling markets is considered as taboo by most of the investors. The general perception among investors is that recession is going to lead to further falls hence eroding the value of their money. Moreover the fear psychosis becomes so huge that investors go ahead with redeeming their equity investments at losses and parking their remaining money in low risk fixed return instruments. Recent example is the case of Indian Mutual Fund Industry where more than 1 million folios were closed in the last one year.


Time and again we keep on reading articles explaining the under mentioned benefits of Equity Mutual Funds:

- Equity is a long term investment option.

- Equity Mutual Fund investment shouldn’t be done from a speculation point of view.

- Equity is beneficial from Tax point of view as it doesn’t incur long term capital gain tax after 1 year of investment.

- Long term returns from Equity are always more than inflation.

Despite of all these benefits published and explained time and again retail participation in Equity is still meagre. Three major factors affecting the growth of retail participation in Equity:

1.) Stringent SEBI regulations for Mutual Fund Industry: It started with banning the entry loads on Mutual Funds in year 2009. This led to a sudden decline in revenues for AMC’s and thereby reduction in the distributor commissions. Many of the small distributors shut shops as they couldn’t make for their expenses. Many financial advisors refrained from aggressive distribution of MF’s and promoted Insurance and Real estate solutions where margins were higher. Most of the distributors found it very difficult to service their customers given sudden cut down in their commissions. This led to a sharp decline in flow of money in MF’s.

2.) Lack of right advisory: Very few distributors have really worked on the advisory model. The investors were never really advised on their investments based on their needs. Funds were pushed citing their benefits and not as per the investors requirements. The good schemes gave smiles to the investors and the bad ones left them clueless with no option but to redeem their funds by booking losses. Also they were never advised rightly during panic redemptions at the time of economic slowdowns as a result booking losses on their investment.

3.) Investors Panic: Panic comes hand in hand with a meltdown. Any bad news or any market meltdown sends shockwave among the investors. Investors need to understand that Equity is a long term product and euity investment needs to be disciplined. Discipline needs to be similar to what is maintained when somebody invests in a PPF or NSC etc and forgets about the money till the maturity. The underlying basis of investment in Indian Equity market is the India growth story. Though India has been facing a slowdown from some time the consumption story still remains intact. A disciplined investment shall pay in the long run and a meltdown shouldn’t be always taken with a panic. It is important to note that since year 2004 the 5 to 7 year rolling returns of BSE Sensex have always been positive. SEBI’s ban on Entry Loads has been an investor friendly step and Mutual Funds as of now are the cheapest and most tax efficient products in the market from a long term investment perspective.

Impact on S & P post US downgrade

S & P is suddenly in the news across the globe. Rating downgrade of US by S & P from AAA to AA shook the world badly. Tremors were felt across the world with markets taking a huge nose dive. Wealth eroded to the tune of $5 trillion leaving investors helpless. Some analysts predict more fall going forward making the scenario jittery.

S & P rating downgrade comes as a surprise when the other two rating agencies Moodys and Fitch have kept the US rating stable at AAA. Although S & P defends the downgrade citing the inefficiency of US govt to handle its debt I personally feel this like an induced mess from S & P. US officials and Analysts questioned S & P's analysis citing errors worth $ 2 trillion in its calculations.

 Also It is noteworthy that US has been reeling under heavy pressure to service its debt which stands at approx $ 15 trillion. But despite of everything US still is the world super power and the probability of US default stands negligible. US may either go for QE3 or borrow more money (very unlikely). The former scenario leads to more money printing whereas the latter will have an implication of higher borrowing cost. But given the size and stature of US it is unlikely that US may not find any creditors.

Investors across the world are still confident of US fulfilling its obligations. The Congress has already taken steps for the same and shall do the needful. And when things start falling back to normal the downgrade impact will take a backseat. It will be more like a bad weather storm doing temporary damages and then things getting back to normal. The bigger question is that will S & P still enjoy the same reputation once US economy comes back on track? It is worth noting that the three rating agencies S & P, Moody's and Fitch popularly known as the Big Three are among the oldest rating agencies in the world and enjoy 95% share of the rating agencies market with S & P being the leader. Already the rating agencies once went wrong during sub prime crises when they assigned AAA rating to some mortgage backed securities which finally went bust.  The sub prime ratings involved many agencies giving the same verdict but here it is just one agency leading to the whole fuss. If S & P's reputation takes a hit once the US economy starts coming on track Moody's and Fitch the closest competitors of S & P stand a fair chance to gain the leadership position.

Security issuers need to get a rating in order to find buyers hence rating agencies are set to stay in the market. It is more about the credibility of rating what matters in long run. S & P is a gaint and is in the market from 1923. Looking at its size and long track it is next to impossible to think about S & P shutting the shop. However the bold step it has taken it will certainly not be among the favourites of White house and its associates / friends. Hence it is a wait and watch situation for the kind of impact S & P might have after the downgrade.

Gold in your portfolio

Gold since ages has been of prime importance for Indians, not as an investment but from an emotional perspective. This emotional value has made Indians the biggest buyers of gold. Out of the total gold produced globally 60% is consumed for jwellery and Indian's are the biggest buyers for this jewellery. But from the last couple of years Gold has emerged as a major investment alternative for many. People call it as hedge against inflation. Investment Managers advise clients to invest 5% - 10% of their total portfolio value in Gold. For some HNI's this value might go higher.

Gold typically has never been the best of an asset class. Although it holds prime importance culturally and economically since many year the last 100 year return of gold has just been 3.78%. A summary of gold returns is as below:



Gold Returns* (yoy)



Gold Price Movement* (1900 - 2010)

 A look at the above table clearly suggests that returns from gold have spiked in the last 10 years. The price movement of gold makes me think how long will this gold frenzy last. Before 2010 the last spike in gold was in year 1980 when it touched the $600 / oz mark. After this for consistently 29 years it traded below this spike. This means anybody who purchased gold at that time was sitting on negative returns till 2009 when gold crossed its previous peak. Leaving the last 10 years aside data clearly suggests that Equities and Bank FD's have been much better asset classes historically. People call gold as an hedge against inflation. Barring last 10 years it becomes difficult for me to agree with this statement.

The only advantage with gold has been that its value has been protected during times of scams. So when equities crashed during 1970's or 2008 scams gold held on to its value which gave people confidence in this asset class. Gold also holds prominence from an economic perspective as Government treasuries store gold as backup for any crisis.

Traditionally people had to purchase gold physically either through Banks in the form of Bars or through jewellers. However Gold ETF (exchange traded funds) and Gold funds have flourished the market in the last few years. They have become a very convenient option for investors to invest amidst soaring gold prices. One might have an allocation to gold with a small investment of Rs. 5000 without any hassels of storage as the investment is held in paper form.
Investment advisors across the board are recomending a 5% to 10% investment in gold. The returns quoted are that of last 10 years and gold is projected as an attractive investment option to boost the portfolio returns. I personally agree with the diversification in gold upto 10%. Anything greater than that looks at little uncomfortable. The global situation has been grim since 2008. Despite the recession getting over many developed nations have still not overcome their problems. US is struggling with deficit, many European countries like Spain, Greece, Ireland etc are already facing defaults on thier debts. China is battling with inflation problems and is hiking its interest rates. Similar problem exists in India. Gold as we discussed above is known to hold its value during crisis situations. This proves to be true in the current globally grim scenario. Till the time the world economy comes back on track Gold seems to be a good investment option. The upward swing in Gold prices is likely to continue for a short tenure post which we might see a stagnation or a correction. Lets not look for a very long horizon of 10 yrs or more from Gold as historically the stagnation of gold has been for a longer tenure than the rise. The moment world economy starts getting back on track I personally feel investors will have better options to place their money.



*www.gold.org  (World Gold Council: Prices considered from year 1900 to year 2010)

Is your Life Insurance Coverage justified?

Problems never come knocking the doors. To cover these unfortunate events and provide a financial security there are various Insurance products available in the market. However to what extent is a person insured becomes a major question. Despite of being insured with multiple policies your family should not fall short of meeting their requirements in case of any eventuality. Hence it becomes very critical to calculate the Insurance coverage before opting for Insurance Plans…….

Insurance still remains a push product in the Indian market. Although it is a very common saying that Insurance need not be coupled with Investments still many buyers look at it from an investment point of view. The other aspect of buying Insurance remains affordability of premium. Very few buyers look at the finer aspects of the plan and the total coverage.

Going by the concept of Insurance, the fundamental aspect to look for while planning the Insurance needs remains the risk coverage.  Human Life Value or HLV helps plan the Insurance coverage of an individual. In terms of Insurance HLV is the value of the cover a person should have to cover his family from the financial risks in case of his unfortunate death. Although Human life value is precious and can never be estimated accurately however from an Insurance perspective HLV can be calculated using two popular methods: The Income replacement method and Expense calculation method:

Income Replacement Method. This method takes into account the total income a person is expected to earn during his lifetime. From this total Income the expenses made on self are deducted and the remaining income used for expenses on family is taken into account for calculation. The total income which is expected to be used on the family’s expenses till the end his working tenure shall be discounted by the risk free rate of return.

Lets take the example of Mr X:


Current Monthly Income of Mr X (a): Rs. 50,000
Expenditure on Self (b): Rs. 10,000
Expenses on Family (a - b): Rs. 40,000
Yearly Expenses: Rs. 480,000
Current Age of Mr X: 40
Retirement Age of Mr X: 60
Inflation: 5%
Total requirement for family till retirement* Rs. 15,871,658
Present value of earned money** Rs. 3,405,236
*Rate of increase in Expenses and Salary is assumed to be equal to inflation
**Discounting done assuming 8% risk free rate


Hence we see that going by income replacement method Mr X needs an Insurance coverage of approx Rs. 3,400,000 to fulfill the requirements of his family in case of his unfortunate death. The idea is that in case of sudden death of the bread earner the family shall get the requisite sum insured and invest the same in an instrument earning returns equal to risk free rate and sustain with the same living standards.

Expense Calculation Method or Needs approach: In this method the present value of all the expenses that a persons family will incur on account of his unfortunate death needs to be added up to arrive at the sum insured. Expenses shall be taken into account based on the goals e.g. living expenses, uninsured debt and mortgages, children’s education and marriage whose provision is not in place, any other emergency expenses etc.

Lets demonstrate this with a simple example:


Monthly Expenses of Mr X's family: 40,000
Yearly Expenses: 480,000
Current Age of Mr X: 40
Retirement Age of Mr X: 60
Inflation 5%
Total requirement for family till retirement* Rs. 15,871,658
Present value of family's total requirement (1)** Rs. 3,405,236
Childrens higher education 5 yrs from now Rs. 1,500,000
Value of Childrens education as on today (2)** Rs. 1,020,875
Childrens marriage expenses 10 yrs from now Rs. 1,000,000
Value of Childrens marriage expenses as on today (3)** Rs.463,193
Total Insurance requirement (1 + 2 + 3) Rs. 4,889,304
*Rate of increase in Expenses and Salary is assumed to be equal to inflation
**Discounting done assuming 8% risk free rate


Hence going by the needs approach method Mr X needs an approximate Insurance coverage of Rs. 4,900,000 which the family can invest in an instrument earning risk free rate of return and fulfill the goals accordingly. In case the insured already possess certain assets the total value of these assets shall be deducted from the total Insurance requirement to arrive at the final coverage amount. This method is more complex and takes into account every minute detail which forms a part of the financial goals of the life thus giving a better picture in planning the Insurance requirements.

Having discussed both these methods it becomes important to consider which one shall be used while advising a client on his Insurance requirements. As mentioned above Insurance is still a push product and very rarely do we find an advisor asking for these minute details from clients. To a major extent even clients are also skeptical revealing these details to an advisor. From an advisors perspective commission and premium becomes important and from a client’s perspective premium, sum insured and returns assume prime importance. Hence planning rarely comes into picture while planning or selling Insurance.

Statistics also reveal that the Indian Life Insurance market stands skewed towards ULIPS. Out of the Rs 261,025 crore*** Indian life Insurance market ULIP’s constitute 50%**** of the total premium. ULIP’s by nature are market linked products with a low Insurance coverage. Also Insurance cos offer higher commissions to advisors on sale of ULIP products. I personally believe that if Insurance had been sold and purchased with some planning the market wouldn’t be so much skewed towards ULIP’s.

It becomes significant for investors to do a judicious planning of their Insurance requirements to financially secure their families from unfortunate events and opt for the plans accordingly. Buying Insurance without planning the coverage is just like living in a utopian world with a false sense of security.

I personally believe Income replacement method can find higher acceptability among investors as it doesn’t ask for minute details like the latter. Spreading awareness on this hold the key. To spread the awareness insurers also have launched Human life value calculators on their sites to facilitate the clients in planning their Insurance requirements. Investors might not reveal actual financial numbers to their advisors but certain averages can always be shared with him to get the right kind of plans. The same awareness needs to be percolated by the insurers among the advisors and channel partners who in turn can educate their clients for a better Insurance planning. Before concluding I would like to mention that HLV is not constant and keeps on changing as with time hence it needs to be reviewed and the Insurance coverage also needs to be taken accordingly.


***http://www.dnaindia.com/money/report_life-Insurance-industry-grew-by-18pct-in-financial-year-2010_1397271
****http://economictimes.indiatimes.com/Features/Financial-Times/Ulips-drive-life-Insurance-cos-growth-engine/articleshow/6042525.cms?curpg=1

Debt investment and Rate hike by RBI

Bond yields are currently hovering at 7.8% mark and the expectations of yields touching the 8% mark are very high. Some reasons supporting this upward movement are:

1.) Government is soon expected to announce its borrowing plans for the year.

2.) Inflation has touched the 9% mark and is zooming towards the double digit figures. Fuel prices have increased after this budget adding to inflation.

3.) Recently (19/03/2010) the Reserve Bank has hiked the Repo and Reverse repo rates by 25 bps to 3.5% and 5% citing inflationary concerns. Economists are expecting a further hike by the Central Bank to contain Inlfation .

This brings good options for investors to shore up their Debt portfolio. Foreign investors have already doubled their holdings in Indian debt market on account of the increasing yields .

Some advisers feel that the hike is not a long term phenomenon. Inflation is expected to move downwards within a range of 6 – 7% within the next 1 year . Lowering of Inflation is expected if the monsoon remains good and government is able to address the supply side concerns. This shall set the stage for rates to come down thus lowering the yields. Hence the advisors are suggesting the investors to shift some part of their portfolio to Debt funds with maturity ranging between 1 to 2 years. This is with the expectation of rates to go down thus raising the prices and hence the NAV. Investors thus may benefit by redeeming a higher amount on their investments.

However looking at the spiraling inflation addressing it is one of the prime concerns of RBI and therefore the market is expecting another rate hike by RBI in April to tackle inflationary pressure. Thus any downward movement in interest rates seems less likely within the next one year if the inflation doesn’t come down. Rate hike might also lead to Banks raising their interest rates for lending. This however may not be an immediate step as Banks also would like to wait and watch before taking a call . And with sufficient liquidity in the market the hike is not expected to have a significant impact on the growth scenario. Stock Market is expected to react on this rate hike with a downward movement thus driving investors towards shifting some of their portfolio into debt. But analysts predict that this should not impact the markets in the long term .

Hence investors can structure their debt portfolio by Investment in Short term debt funds as it clearly seems to be a better bet till the time a clear picture emerges on inflation and interest rates. Longer term debt funds will be suitable once the interest rate reach its peak and is expected to come down in the near future.

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1 http://www.bloombergutv.com/industry-news/banking-industry-news/47519/economists-expect-more-hikes-in-april.html

2 http://www.bloombergutv.com/news/latest-business-news-india/47525/rate-rise--sign-of-things-to-come-.html

3 http://economictimes.indiatimes.com/quickiearticleshow/5700074.cms

4 http://www.moneycontrol.com/news/economy/will-rbis-policy-rate-hike-impact-corporates-borrowers_447807-0.html

5 http://www.moneycontrol.com/news/market-edge/mkts-to-react-–ve-to-rbi-rate-hike-movemonday-experts-_447803-1.html

Qualified Institutional Placement

Qualified Institutional Placement (QIP's) the buzz word heard commonly these days among India Inc. Corporates raising money through QIP's has become a frequent phenomenon. As per a report published in Bloomberg* on Oct 08, 2009, Indian companies have raised $7bn through QIP's this FY and plan to double this no by the end of this FY. Some prominent QIP offerings are Unitech raising 1620 Cr and Indiabulls going a step ahead by raising 2600 cr.

But what is actually a QIP?
QIP is a mode of raising money for the Corporates. A tool for private placement introduced by SEBI in May 2006. In a QIP a listed company raises Equity shares, fully or partly convertible debentures or any other securities apart from warrants to a Qualified Institutional Buyer (QIB's: which includes Public Financial Institutuions, Mutual funds, FII and Venture capital firms registered with SEBI).
This was introduced by SEBI to avoid Indian companies raising money through overseas markets and avoid dependency on foreign capital which was raised through Foreign Currency Convertible Bonds (FCCB's) and Global Depository Receipts (GDR's).

QIP's have become a cushion for Corporates for easy and speedy capital raising from the market unlike Public offerings. A Public Offering needs filing with SEBI and also a considerable time in hitting the markets whereas a QIP doesnt require any filing formalities. Also the complications which the companies face while tapping the overseas markets are not present with QIP's thus giving the corporates a comfort in raising money. Corporates through QIP can directly approach the QIB's thus asking them to let loose their pockets. However the QIP offer needs to be managed by a SEBI registered Merchant Banker. The offer documents need to placed on the website of Stock exchanges and the company raising money.
Exit options in case of a QIP also are easy as Investors donot have any lock in period for thier investments. They can exit if they find vauations of their securities attractive enough at any point of time.

The economy is ripe with improving positive sentiments after an unforgettable recessionary downturn. Corporates also would like to take advantage of this situation by raising money to service thier debts and fulfill thier cash requirements#. The rising markets and profits announced by India Inc are giving confidence to the Investors. The Investors although are not going frenzy compared to some previous years but after a downturn are gradually gearing up to cautiously invest their money and get some value out of their investments in the improving economic scenario. This leaves a good scope for more QIP's to be rolled out by Corporates looking forward for investors who seek to get value for their investments by participating in the Indian growth story.

Some good Sites for more info on QIP's:
http://indianblogger.com/2009/06/05/what-is-a-qip-why-is-it-hot-now/

http://en.wikipedia.org/wiki/Qualified_Institutional_Placement

*http://www.bloomberg.com/apps/news?pid=conewsstory&tkr=C%3AUS&sid=aHXW8PZ7Uj3I

#http://economictimes.indiatimes.com/Markets/Stocks/Market-News/What-is-QIP/articleshow/4619072.cms