The cost to follow this path is high, as it puts pressure on borrowings, its costs, and on deficits as the supply of government paper increases manifold. In India, net government borrowing for FY22 is projected at Rs 9.25 lakh crore compared with Rs 4.25 lakh crore in FY20.
Crude price rise is a cause of concern, especially for countries like India. India substantially increased duties on crude to garner revenues to fund the Covid-19 stimulus packages, thereby making petrol and diesel very expensive.
With rising inflation, higher borrowings and deficits, a rise in interest rates would be an ‘in-parallel’ move. This is being witnessed globally. India has seen the 10-year G-Sec yields move up from 5.9 per cent to 6.2 per cent, and they are currently indicating an upward bias. Similarly, yields on the global bellwether 10-year US Treasury have moved up from 0.82 per cent three months ago to 1.37 per cent on the back of a rise in input price inflation. Such large movements in US treasury yields can surely change fund flow among the global economies, as risk-off trades and sentiments gain momentum.
With the local fiscal concerns added, the Indian market is seeing increased volatility with meaningful corrections in equity and debt markets over the past two weeks.
While interest rates are pushing upwards, RBI is expected to keep the rates in check. The economic revival mirrored by corporate growth in Q2 and Q3 of FY21 is quite encouraging and meets the expectations that FY22 GDP growth will be in low double digits. In fact, if the Q4FY21 results are as good (if not better) as Q3FY21, then the projected GDP growth for FY21 could improve from the budgeted (-) 7.5% to a (-)6.5% to (-)7.0% range. In FY22, corporate earnings are expected to grow 25-35% (Nifty50 companies).
On one side you have the optimism of good economic growth and on the other side is the overhang of large borrowings and increasing inflation and interest rates. As we go through the rest of Calendar 2021, markets would look to strike a balance between the two based on the numbers leading to increased volatility in equity and debt markets. While the medium- and long-term outlook remains positive, near-term volatility can spook investors. And one of the behavioural trends of a ‘spooked investor’ is to sit on the sidelines. Remaining in cash in times of moderately high inflation can hurt portfolio returns.
Timing the market has, more often than not, resulted in lower returns. While ‘rupee cost averaging’ will help, opportunities to tactically double up on systematic investments when the market takes a meaningful correction should not be missed. Systematic transfer for investments should not be spread out for more than three to six months and low cost and low beta investments in ETFs and factor/quant funds can be a good investment option.
Trimming the equity tail is an exercise best suited for today’s market environment. Being meaningfully invested in strong conviction investments/managers will help sharpen the portfolio.
For FY22, the risk in the fixed income markets is more likely to emerge from rising interest rates than from possible credit downgrades/defaults. Corporate balance sheets (including those of banks and NBFCs) are much healthier and, hence, less likely to result in negative credit events.
The flattening of the yield curves is expected through a possible increase in short-term rates rather than a drop in long-term rates. Remaining invested in the best credit portfolios with an average of three to four years of duration and a yield-to-maturity or around 5-6% should be the strategy. This, along with calibrated investments in good quality AA+ and AA papers and market-linked debentures, can be a good barbell-like strategy on risk.
The larger portion of low-credit risk investments can yield 5-6% per annum, while the smaller proportion of high(er) risk strategy can yield between 8-10% per annum.
Sitting on the fence can mean a higher cost to pay rather than just a temporary fall in values. As is often said, the time spent in the market is much more important than timing the market. Be meaningfully invested with not more than 20 per cent held as dry powder – in both debt and equity allocations. This is the time to take advantage of the volatility. Fear perpetuates more quickly than greed, and hence volatility could be higher on the downside. But there lies the opportunity. Create cash by trimming the tail or by allocating more for the opportunities that could be created in 2021, as there is no second-guessing on the growth that India will see over the next few years. Be cautiously opportunistic in these volatile times.
(Nimish Shah is Chief Investment Officer for listed investments at Waterfield Advisors. Views are his own)