There is light at the end of every tunnel. At least, that’s what stock market investors seem to think. The latest example is in subdued economic growth numbers. India’s GDP growth in third quarter of fiscal 2019 (3QFY19) slowed to 6.6 per cent from 7 per cent in the previous quarter and 7.7 per cent a year ago, but that has brightened hopes of aggressive interest rate cuts by the Reserve Bank of India (RBI) in the short and medium terms. With the GDP growth reading below Bloomberg consensus estimate of 6.7 per cent, the focus of policymakers is on consumption revival to improve prospects. There is nothing better than a stimulus in form of an interest rate cut, and that is good news for stock markets, where key benchmarks have moved in a range for the last 12 months. Additionally, if headline (CPI) inflation remains below 4 per cent YoY and food inflation is tepid for the fifth consecutive year, expect up to 75 basis points worth more rate cuts in the ongoing interest cycle.
GDP data released for Q3FY19, along with the second advanced estimate for FY19, showed the obvious. The expected decline in H2FY19 was not a surprise, but it shows the fragile nature of growth. Q3FY19 real GDP growth decelerated to 6.6 per cent. Full-year growth estimates had to be cut down. Full-year FY19 growth is now estimated at 7 per cent, down from 7.2 per cent earlier. This puts the implied growth in Q4FY19 at 6.5 per cent, lower than Q3FY19.
A look into the Q3 numbers shows that the sluggishness (7 per cent in Q2 i.e. previous quarter and 7.7 per cent a year ago in same quarter i.e. Q3) was largely due to the slowdown in private consumption growth. There was a perceptible decline in government consumption spending growth too. The only ray of hope was in form of fixed-investment, primarily driven by high government capital allocation.
Going ahead, many believe that demand conditions should look better, especially on the consumption side. But the investment side is expected to decelerate. Higher government spending ahead of the May 2019 Lok Sabha elections and the consumption boost in Interim Budget FY20 has opened the door for increased spending in the rural and agriculture sector. The tax sops leading to higher disposable income for households can also lead to a strong fiscal multiplier effect in the coming quarters. In addition, measures to move PSU banks out of the PCA framework restrictions augur well in terms of lending outlook.
Having said that, lead indicators suggest that the growth slowdown was sustained in 4QFY19. For instance, core infrastructure industries grew 1.7 per cent YoY in January 2019, down from 2.6 per cent earlier. With growth slowing and inflation below estimates, markets are expecting another rate cut by the RBI at its April 2019 monetary policy meeting
Stable monsoon, crude prices
Markets are expecting no major negative surprises from monsoon and oil price. There is an assumption of normal rainfall and stable crude oil prices. If this situation comes into play, one can expect the country’s core inflation to come off 100 basis points in FY20, opening the window wide for the rate cuts. Softer inflation will give the RBI enough leeway to ease monetary policy. We have already seen that the RBI has renewed its focus on supporting growth.
Stock markets have different voices. One of the sections believe the monetary transmission in terms of banks’ lending and deposit rates will continue to be partial and delayed, even if rates are cut aggressively. They cite a wide gap between credit and deposit growth as the cause. There are also downside risks like tight domestic liquidity conditions and slowing global growth. Whatever happens, it is clear that the central bank will try to ease interest rates to boost growth. The RBI, at least in the current regime, is keen on being perceived as a supporter of growth.
What investors should do
If interest rate cuts happen, this will be welcomed by stock markets. Elections will come and go, but interest rates tend to stay around. Lower interest rates are good for corporate earnings and consumption. Consider taking exposure to technology, corporate banks, consumer staples and select consumer discretionary themes directly or through equity mutual funds. Have 5-10 per cent of cash in an event there is a negative event that drives down equity asset prices sharply lower - this will be a buying opportunity.
How will interest rate cuts play out for debt markets? There is no easy answer. The undeniable fact is that credit issues continue to persist and are a concern for many. If you want to focus on debt (directly or through funds), start building a diversified portfolio of short to medium duration and corporate bonds. Retail investors can avoid taking exposure to credit risk. Prefer short to medium duration AAA oriented strategies. Look to deploy additional capital on any spikes in interest rates. For risk-averse investors, ultra short term and liquid funds would be a safe choice.
The author is a financial journalist with 14 years of experience