India Ratings: During rate-cutting cycles, IFIs increase allocations to emerging markets, but this time could be different: Balasubramanian

A balasubramanianManaging Director and Executive Director, ABSL AMCAccording to Balasubramanian, as borrowing becomes cheaper, there will generally be a tendency to look for markets that can outperform the global market. Overall, we have seen allocation to emerging markets improve. But Balasubramanian believes it could be different this time, given that while there will be a rate cut, the cost of borrowing will not come down very drastically; it will be gradual. Renewed interest by IFIs in India will not only depend on a lower interest rate regime but also on India’s valuations and growth expectations compared to the rest of the markets. But definitely, IFIs would look more favorably on India. India will continue to be one of the most promising markets globally.What is expected? Can we expect a 25 basis point or a 50 basis point cut from the Fed? Will markets react to either scenario, as a 50 basis point cut may signal a deeper problem in the economy?
A balasubramanian: There are different expectations. I’m basing my expectations on the general trend that the United States has followed. Employment rates in the United States have been quite good, while unemployment rates are low and growth has not faltered. So far, the economy has been doing quite well and inflation remains borderline. So, taking all that into account, as long as growth continues, there will always be the question of whether we have enough room for them to cut rates significantly.

Secondly, this will be the first cut after two and a half years of rate hikes in cycles. The rate cut has to be done in a way that shows a trajectory that there will be either an aggressive or a moderate rate cut. I think they will probably take the second path, i.e. a moderate rate cut, without creating too high expectations and giving signals that there will be a significant rate cut. There is a high probability that it will be a gradual reduction, unlike the time when they raised rates on a scale of 50 and 70 basis points. Although the reduction could probably be 25 basis points, that is my intuition. This is purely based on how the US economy is behaving, both in terms of growth, corporate profits and unemployment rates.

Historically we have seen that when the rate reduction cycle begins, many IFIs turn to the emerging markets Because that is where the biggest delta is. Do you think this will be the stimulus for foreign investors to come back to India? This year, it is all about foreign investor flows and retail money coming in, but at least in September there are signs that foreign investors are coming back to India.
A balasubramanian: There is some likelihood that as the rate-cutting cycle begins and interest rates become cheaper from a borrowing perspective, liquidity will improve globally. As borrowing becomes cheaper, there is generally a tendency to look for markets that can outperform the global market. Overall, we have seen the allocation to emerging markets improve, but I think this time it could be different, given that while there will be a rate cut, the cost of borrowing will not come down very sharply, but again gradually. The 10-year bond is around 3.85% and the general borrowing rates in the US, for example, mortgage rates are around 5.5% or 6.5%, and they are not going to come down immediately as it will take some time for borrowing rates to adjust. So, it will be a gradual process.

While people will start looking at other markets, the impact of this on the currency will also have to be taken into account. Therefore, renewed interest from foreign investors in India will not only depend on a lower interest rate regime, but also on our valuations and growth expectations relative to the rest of the markets. All these factors will determine the decision-making process, but the direction will certainly be more towards a more favourable view of the Indian market by foreign investors. Among the world markets, India will continue to be one of the most promising.

Within everything portfolio allocation In general terms, do you think a major realignment of portfolios is needed to split them between debt and equities? In equities too, during the last cycle, discretionary and rate-sensitive stocks such as autos performed well and consumer spending received a boost. In terms of sectors, do you expect history to repeat itself?
A balasubramanian: However, restructuring is necessary on an ongoing basis because the market has gone through cycles where each sector behaves differently at different times. Therefore, restructuring portfolios as a course correction is a necessity. interest rates If rates are cut, we must also assume that this will also happen along with a rate in the overall growth of the economy. Therefore, the growth rate of the overall economy will also slow marginally. Therefore, one must keep in mind that rate cuts will eventually boost consumption and real demand, and that cycle will take some time. Therefore, from a portfolio balancing standpoint, one should definitely consider taking valuations into account.

Secondly, long-term investing may offer a better return outcome as fixed income offers an opportunity in the current situation. Perhaps, once the rate cut starts, the opportunity will go away. In the current situation, there should be some allocation towards fixed income schemes, given the fact that equity markets have rallied quite a bit and valuations are tight. We have all been expecting a minor correction, but it has not happened for a variety of other reasons. Keeping this in mind and considering all the risks that are evolving as far as the equity market is concerned, it would be ideal to balance the portfolio with a fixed income component.Fixed income plans They are also offered in hybrid schemes and even large-cap funds, mega-cap funds or flexicap funds which essentially focus on larger companies. Even the larger companies during this period have underperformed for various reasons including the financial sectors. But these are the sectors that would potentially start recovering as interest rates start falling.

Are you saying that it is better in terms of risk-reward to be in large-cap companies at the moment and especially in underperforming ones like financials and also private banks because public sector companies have gone up?
A balasubramanian: Large-cap funds and flexible-cap funds have a higher representation of large-cap names. And within this sector, there are many others. But if we take the banking sector as such, it is clear that as interest rates start coming down, the accounts of the banks will also adjust. The transition process will take some time and it will not benefit the sectors immediately, but over time, the sector will start recovering. Demand for credit will come back and liquidity will improve. As credit growth starts coming back from 13% to 24%, I think these are some of the things that will start helping the sector recover.

Anyway, they are all part of the portfolios, both large-cap portfolios and flexi-cap portfolios. About 20-25% of the portfolio is in financials. And as interest rates start coming down, borrowing rates will come down and then consumer demand will pick up. That is the cycle that we will have to see. But having said that, Indian interest rates from a borrower’s point of view have never been very expensive. So for the rate cut to have an impact on borrowing costs, it will be a very gradual process rather than a one-time process, cutting back to boost demand.

The rate cut you mention will also reduce borrowing rates but it will also reduce term deposit rates and given the current trend where we see people preferring to choose or keep money in mutual funds rather than fixed deposits, won’t these lower term deposit rates boost flows into mutual funds? Do you expect that?
A balasubramanian: Ideally, from a risk-reward perspective, how can one capture the current debate on interest rate cuts? I think what we are discussing is an opportunity that could emerge from the upcoming interest rate cut cycle. Therefore, the best way to take advantage of the interest rate cycle is through fixed-income schemes. Mutual fund Corporate bond funds or money market funds and some other funds, which take duration call option or even government debt funds which take duration call option and naturally you get the profit.

From an investor’s point of view, naturally, mutual funds would be the natural choice, given the market value and whatever rate movement happens, it is reflected in the portfolio at that point in time. So, investors can see that benefit in the portfolio, unlike deposits, where the interest rate is what we get, whereas with mutual funds, you get a transfer and you have to live with both ups and downs. But in the rate cut cycles, fixed-income schemes have benefited from an allocations point of view.