The successive increases in policy rates by the Reserve Bank of India have necessitated changes in investors’ portfolios. Some ideas on how one should go about those.
The policy measures of the Reserve Bank of India (RBI), the country’s apex bank, are watched with a lot of interest. These are among the most significant drivers of the economy and financial markets. RBI is in charge of the monetary policy, which has a great impact on liquidity conditions and interest rates. The Bank has been entrusted with managing liquidity and inflation in the country. The investing class, therefore, needs to understand the basics of monetary policy and how it impacts investment.
STANCE OF MONETARY POLICY
RBI has several tools in its hands to release or control liquidity in the system. Two of the most important tools are the cash reserve ratio (CRR) and the liquidity adjustment facility (LAF). CRR is the proportion of their deposits that banks have to keep with RBI. Raising CRR is one of the most effective ways for the RBI to suck liquidity out of the financial system, reducing demand in the economy and, thereby, helping curb inflation.
LAF is a mechanism through which RBI lends to and borrows from banks for very short periods, typically just a day. The repo rate is RBI’s lending rate and the reverse repo rate is RBI’s borrowing rate. These two rates help RBI influence short-term interest rates in the rest of the financial system. When RBI increases these rates, the banks also increase deposit and lending rates.
The effect of increase in policy rates is that the banks increase deposit rates and lending rates. Rising interest rates are adverse news for the stock markets. The high cost of capital directly affects the performance of companies in rate-sensitive sectors. For example, banks may not be able to pass on the entire increase in cost of funds to their customers, thereby affecting net interest income.
Higher loan rates may force individuals to postpone purchases of homes, vehicles, consumer durables, etc, and thereby bring down the overall demand for loans affecting banks and supplier companies such as real estate, auto, infrastructure, etc.
Most businesses need capital to run their day-to-day operations that require a mixture of debt and equity. Companies with huge debt on their balance sheets and those needing greater funds in the form of debt for expansion are worse affected. For, when interest rates rise, so does the cost of borrowing.
Higher rates also increase the interest cost burden of indebted companies and thereby bring their profits down. With inflation becoming a major issue, interest rates can only go up. So, investors should avoid rate-sensitive sectors like financial services, real estate (and, to some extent, automobiles) at least for some time.
Cash-rich companies sit pretty during these times. They don’t have to borrow capital and can earn from short-term investments of the cash in their hoard. The benefit they earn on the treasury income won’t be substantial. But cash becomes handy now because they can fund their growth without resorting to high-cost debt. Companies with surplus cash are able to benefit by way of higher yield on investments.
SAFE HAVEN
Sectors such as pharmaceuticals, fast-moving consumer goods and information technology are considered non-interest rate sensitive by investors and are safe to park money during a high-rate regime. This is because you can postpone buying a house, but you cannot postpone buying day to day things like biscuits, cosmetics, detergents, toothpaste, etc, which are a daily necessity or medicines.
REVERSE REPO RATES
It is the rate at which RBI borrows from banks. RBI increased the reverse repo rates by 200 basis points in less than a year’s time.
The table above gives the return for one year for the CNX NIFTY and various sector indices. As seen in the table, due to increasing interest rates, the NIFTY has given nominal returns. However, sectors such as pharma and FMCG have better returns. The auto segment has given the best returns but it was primarily because of hammering last year.
As far as individual stocks are concerned in Nifty, those that have given greater than 25 per cent returns are Sun Pharma (49 per cent), ITC (41 per cent), Hindustan Unilever (27 per cent). These stocks are from defensive sectors such as pharma and FMCG.
The worst performers have been realty sector stocks such as DLF (minus 24 per cent), Unitech (minus 58 per cent), IDFC (minus 27 per cent), Maruti(minus 15 per cent), etc.
With the impact of all the hikes yet to take place, investors may position their portfolio with less of interest rate-sensitive stocks. However, that should not make them completely disinvested from these stocks , as these may give bumper returns later. Having a proper balance of the stocks will help optimise returns.
The writer is a freelancer
