Where is the Rupee headed?

"People know the price of everything, but the value of nothing" - Oscar Wilde

Since 2008 we have seen sharp correction in rupee against major currencies of the world. The INR has moved from 39 to 67 levels against dollar in 8 years which numerically speaking is a 71% correction in 8 years or an almost 7% annualized correction. Majority of us believe that we still have an inflation differential of close to 4% with developed countries and that will be reflected in currency depreciation. Consensus on the street suggests that INR will continue to lose 3-4% every year to remain competitive.

In my opinion it’s extremely important to crystal gaze the relative value of rupee against major currencies. Economics suggests that prices are determined by supply and demand. RBI has kept supply of rupee in check for the last four to five years due to which we witnessed deficit liquidity in that period. This was primarily done to control inflation.

Contrary to India, majority of developed countries were following easy monetary policy. They tried to keep real interest rate negative to push up asset prices, especially real estate.

·         Rupee Supply – RBI today has structurally brought down inflation by keeping rupee supply in check. There was limited monetary expansion due to this tightening of liquidity. Going forward liquidity will ease and RBI will ensure steady expansion in money supply which will increase supply of rupee in the system.

·         Rupee Demand – In the past few years we have opened up our economy and allowed FDI in few of the largest sectors of the economy like railway & defense. Passage of GST constitutional amendment bill will encourage more FDI & FII flow in the country. The stability shown by INR in the past three years is helping foreign investors gain confidence. Fall in commodity prices has significantly improved the balance of payment situation. Also in a world of monetary expansion, INR being short in supply will start gaining because of demand supply mismatch.

As Carl Richard quotes – “Tomorrow’s Market Probably Won’t Look Anything Like Today”. I would like to remind you all of a period between 2003 - 2008 where rupee gained against dollar over an five year period. Common sense tells us that we are going to witness something similar.

 

We would like to put our thoughts on asset class behavior during time to come –

·         Debt – Currency appreciation will create deflationary trend in the economy. In that environment rates will fall faster and deeper than what we anticipate. Majority of us are taking reinvestment risk in our portfolio by being on the shorter end of the curve. I would urge investors to lock their yield at a higher rate by investing in long term funds. Also I would urge people to buy quality and liquid papers where there is no credit risk.

·         Equity - Currency appreciation will help majority of domestic facing companies primarily due to lower input cost. GST and FDI in railway & defense will also help towards this cause.  I would urge investors to look at domestic facing companies from auto, auto ancillary, FMCG, engineering, cement, logistics and other allied manufacturing industry as they look poised to create a multiyear trend.

Budget - 2016

Changing Guard

Markets entered budget day on a bearish note anticipating negative outcome from Budget 2016. There were expectations of a 2% hike in service tax rate from 14.50% to 16.50%. It was also expected that LTCG on equities will be extended from one year to three years while some quarters were expecting the same to be taxed as well. What surprised the street was neutral stand on taxes and moderate increase in overall tax revenue. We did our own study of Budget 2016 and in our opinion it’s a CHANGE OF GUARD for the Indian economy.

1.       From services to agriculture & manufacturing – most of the thrust in the budget is towards agriculture, infrastructure and some manufacturing sectors. The budget is neutral to negative for services with marginal increase of 0.50% as agriculture cess. Agriculture, infrastructure & manufacturing are the biggest job providing sectors. Budget has given huge outlay for roads, irrigation, allied agriculture sectors and some of the manufacturing sectors got incentivized with change in excise and custom duty. This will help to balance the economy and increase weight of manufacturing sector in the economy.

2.       From urban to rural economy – this budget has focused on building rural economy by focusing on social welfare schemes and outlay for agriculture sector. Also outlay for roads will help in connecting villages. Higher taxes for four wheelers @ 1% to 4% is a clear signal that the government’s focus is to build rural India at the cost of urban India. This will help in reducing income inequality, improve rural wages and improve social infrastructure of country.

3.       From rich Individuals to poor people – some of the taxes like additional surcharge for Rs. one crore plus income and 10% dividend distribution tax for individual earning more than Rs. 10 lac dividend income is a clear sign that rich people will have to pay more taxes to benefit the poor.

4.       From profit & loss account to balance sheet – the government has been levying higher taxes on diesel and petrol over the last year. The budget has given direction that this amount will be spent on making roads. For last so many years we are struggling to convert our economy from consumer led to investment led. This budget will help in changing direction of economy towards investment.

In our opinion this budget was a balancing act and will try to move economy towards sustainability. This CHANGE OF GUARD will create wonderful opportunities for large sectors and companies. Sectors like two wheelers, cement, agri input, auto ancillary, chemicals, consumer durable, rural consumption and other allied sectors will gain. We strongly believe that this CHANGE OF GUARD will help some of the business to grow at higher pace and hence get premium valuations compared to the market. The recent correction has made this story more compelling.