Good rains to boost long-term bonds, debt funds & agri company stocks
Widespread rains over the past few days have washed away investor worries about a poor monsoon. The monsoon has already covered most of India.
What should investors do now? They could wait for a few months to make sure that the monsoon is indeed normal before taking any action. “A good monsoon in June doesn’t mean a normal monsoon for the entire season. We have to wait for some more time. If rains continue like this for the next 15-20 days, we will get greater confidence,” says Indranil Sen Gupta, India Economist, Bank of America Merrill Lynch.
However, the problem with this strategy is that by the time there is certainty about the monsoon outcome, the market would have reacted and prices would have spiralled. Earlier, the equity and debt markets had reacted negatively to the IMD’s deficit monsoon forecast.
The RBI’s recent hawkish stance has not dampened the mood of investors. This is because the RBI has not said there won’t be any further rate cuts, but that “it will be based on incoming data”. The monsoon is a very important data point. A good monsoon will help reduce inflationary pressures further, especially food inflation. This will allow the RBI to concentrate on growth. Faltering global growth and a nonhawkish stand by the US Federal Reserve are other factors that will help the RBI’s hand.
What is perking up the market sentiment now is the fact that the upcoming rate cut from the RBI is not a one-off incident and the central bank is expected to continue with the cuts in future also. “It is not going to stop with its 25 bps cut next time. If volatility in inflation is controlled, it may continue to cut in the coming years also,” says Suyash Choudhary, Head of Fixed Income, IDFC Mutual Fund. This is because the government is trying to address the structural issues that result in high inflation. For example, the government has decided to go with a moderate hike in minimum support price this year, despite a weak rural income. To mitigate the weak rural income, the government is working on alternative plans of improving rural agriculture infrastructure. The project to integrate agriculture produce marketing committees (APMCs) is a good move. It will help farmers to get better prices without pushing them up for end consumers. Global demand for commodities is also weak and this is another factor that may keep inflation down in future.
Impact on debt investors
The rate cut by the RBI and the resultant fall in interest rate structure will have a diverse impact on debt investors. Banks cutting interest rates on FDs and RDs will be bad news for investors who use this route. Since the rates are expected to come down further in coming years, what they need to do is to lock into high rates available now. People who don’t have money right now can lock in at higher rates through recurring deposits.
Investors who invest money in long duration bonds and debt funds will be the biggest beneficiaries of a fall in interest rate. Hopes of an early rate cut by the RBI has already started reflecting in the bond market. The 10-year yield that moved up from the recent low of 7.64% on monsoon concerns has started moving down again with the onset of monsoon. Once there is more clarity, experts feel this bond rally will continue for some more time. “The inflation now is averaging around 5% and if the government is able to control the farm product prices, the bonds will continue to rally. The 10-year bond yield may fall below 7.5% before this financial year,” says Choudhary.
Should investors buy long-dated bonds themselves or use long-dated debt funds? If possible, they should invest directly in bonds because of its tax advantage. While a one-year holding period is needed in listed bonds to get them classified as long-term capital gain, it is three years for bond funds. On the other hand, low liquidity is a problem faced by direct bond investors.
“Bonds are not very liquid, so the investors should be ready to hold it till maturity,”says S. Sridharan, Head of Financial Planning, FundsIndia.com. Since there is a default risk, investments should be restricted to papers that are rated high. Highly rated tax-free bonds, and those from public sector undertakings, are now available in the range of 7.2% to 7.5% and this is attractive for investors who are in the high tax brackets (see table). Since a big issue size is linked to the liquidity, we have only selected the counters with an issue size of Rs 500 crore for showcasing.
Impact on equity investors
A good monsoon and the resultant boost to agricultural production should help push up demand for companies catering to agricultural needs. “Good monsoon is beneficial for agro companies like Rallis India because their demand will go up,” says Kartik Mehta, VP, Institutional Research, Sushil Finance.
Tractor manufacturer Mahindra & Mahindra is another company that will benefit from higher agricultural production and rural income. More importantly, this counter has also not participated in the recent rally in the market. Improvement in rural income will also push up the prospects of several FMCG companies that have made inroads into villages. However, high valuation here is a problem for prospective investors.
A good monsoon and resultant fall in inflation will help the RBI to go for fast rate cuts and these will be a boon for rate-sensitive sectors. Automobile companies will be a major beneficiary because of a fall in interest and increased rural income. Companies like Hero Motocorp will benefit on both counts. Highly leveraged infrastructure companies are another segment that will benefit from the fall in interest rates.
Though both private sector and public sector banks will benefit from a good monsoon, the impact will be much more on PSU banks.
First, they are facing non-performing asset issues and a good monsoon will reduce the problem arising from the agriculture side. Overall fall in interest rates will also reduce the NPA problem emanating from industries. Second, PSU banks have higher exposure to government securities and, their treasury gains will be higher due to the fall in interest rates. Lower valuation and their growth inching closer to that of private sector counterparts are the other reasons. “Valuation is much better for PSU banks.
With the government thrust on infrastructure, top PSU banks may report credit growth comparable with the industry average,” says Jaspreet Singh Arora, Senior VP, Spark Capital. However, investors need to be choosy. “Our pick is Bank of Baroda, because of high growth, good asset quality, good management, international diversification and also good valuation,” says Arora.