Raghuram Rajan is in for the long haul; investors should tag along

Equity investors should stay invested or make fresh investments in the markets with a minimum holding period of three years while fixed income investors should look to take advantage of expected fall in interest rates by investing directly in government and corporate bonds or by investing in bond funds for a period of 36 months and longer.

RBI governor Raghuram Rajan explicitly stated in the policy review today that while the macros were improving in the economy, much work still needs to be done for the economy to make a strong foundation for the future growth. Rajan is in for the long haul and is willing to put aside short-term considerations for long-term benefits.

His policy is just what is required for equity and fixed income investors as there will be benefits of growth with lower inflation expectations over a period of time. After a volatile session, the equity market also seems to have finally read the fine print. The Sensex and Nifty closed up about 0.7 percent. The indices had fell about 0.8 percent in the intraday.

Yield on the benchmark 8.83 percent 2023 government bond is up 9 bps. The bond prices and yields have a negative correlation.

The rupee also erased all its intra-day losses and is now trading at 60.83 against the dollar. The Indian unit had hit a low of 60.995 and high of 60.695 in the intra-day.

The rupee has fallen around 1.5 percent over the last couple of weeks on global issues of Argentina debt default and the Middle East tensions.

The RBI cut the Statutory Liquidity Ratio (SLR) of banks by 50 bps in its policy review. Apart from this there was no change in its policy rate repo rate and banks’ Cash Reserve Ratio (CRR). Both have been maintained at 8% and 4%, respectively.

The markets were expecting some indications from the RBI on rate cuts going forward as the Consumer Price Index (CPI) inflation had fallen to levels of 7.31 percent in July, which is a multi-year low. The central bank, however, did not provide any comfort to the market on the rate front even though the policy stated that it was satisfied with the way inflation was trending down. The RBI’s target for inflation is 8 percent and 6 percent for January 2015 and 2016, respectively.

The markets may have been disappointed that Rajan, while appreciating the fact that inflation is coming off, indicated that until inflation is well on its way down towards 6 percent, he will not be in a hurry to easy monetary policy.

The markets are mostly short sighted as positions are built on unreasonable expectations, in this case a highly dovish policy statement that did not come about. That was the reason for the negative intraday reaction to the policy.

The SLR cut is by itself positive as it signals that the RBI is confident of the government’s commitment to fiscal consolidation with Budget 2014 drawing a fiscal roadmap of 4.1%, 3.6% and 3% deficit over this fiscal and the next two fiscal years respectively.

Looking forward over a two to three year period, the horizon appears bright with low fiscal deficit, inflation well under control and economic growth picking up. The RBI has maintained its forecast GDP growth of around 5.5% for this year as growth indicators of IIP (Index of Industrial Production) and exports are up.

IIP growth for the first two months of this fiscal is at 4% against negative growth of 0.5% seen last year. Exports are up by around 9% in the first quarter of this fiscal against a negative 1.5% growth seen last year.

India’s foreign exchange reserves are at record highs of $320 billion from levels of $280 billion seen a year ago. The rupee has appreciated 11 percent since August 2013 when it touched record lows of 68.80. India’s current account deficit is down from levels of 4.7 percent of GDP to 1.7 percent in fiscal 2013-14. Capital flows are robust with FIIs investing $16 billion in equities and debt fiscal year to date.

India is definitely on a better wicket than what it was last year, when macro indicators from fiscal deficit to inflation to current account deficit were highly negative driving down the rupee to record lows on worries of Fed tapering of asset purchases.

The Fed has lowered its asset purchases from $85 billion a month to $25 billion a month since December 2013 and will end purchases by October 2014. The rupee is looking strong despite the Fed taper and this is largely due to improving macros.

Arjun Parthasarathy is the founder of InvestorsareIdiots.com and INRBONDS.com.