Prudent fiscal policy combined with structural reform is the way forward and the Indian economy simply cannot afford the Food Security Bill, says Nomura
The sharp downturn that the rupee’s trajectory has taken recently has sparked off concerns about an interest rate hike as a possible policy response. The rationale for that would be to raise interest rates to contain aggregate demand to address the current account deficit and attract more capital inflows in order to help the balance of payment.
According to Nomura however, conventional theory may not be applicable to India's present macro-economic situation for three reasons. For one, Nomura says that the problem that needs to be addressed is not one of a high aggregate demand, but of a lack of supply. Next, it remains debatable as to whether capital flows into India are growth or interest sensitive. Finally, domestic demand has already collapsed, with non-oil/non-gold imports declining, suggesting the presence of weak private demand. Nomura says that the cost of hiking interest rates could do more harm than good, given rising domestic leverage on corporate balance sheets and their inter-linkage with banks.
Nomura invokes the theory of the impossible trinity, according to which a country can only have two out of the three from among an open capital account, a fixed exchange rate and an independent monetary policy. Given a low risk of capital controls, Nomura holds that the Reserve Bank of India (RBI) will have to decide between letting the currency adjust on its own or losing control over its monetary policy. Nomura’s recommendation is that the RBI should let currency adjust gradually, given limited forex reserves and a dismal domestic growth outlook.
Nomura says that while the competitive gains of the rupee depreciation are limited by supply-side considerations, the negative implications of higher imported inflation, delayed rate cuts, high asset price volatility, the increased cost of foreign currency debt, etc are many.
Nomura's report suggests that India's issues stem from a lack of fiscal and structural reform, with the rupee depreciation being a by-product of that. The brokerage recommends that the ideal response would be to implement a prudent fiscal policy, along with structural reforms that would put a check on consumption demand, ease inflationary pressures and eventually allow the RBI to re-focus on growth. The report explicitly says that government spending is budgeting to rise 16.4% this year, and with the Food Security Bill also being prepared, the Indian economy simply cannot afford this at the moment.
In today's Asia Chart Alert, Nomura expressed serious concern for India's rising short-term debt, even with a fully funded current account deficit, as it has increased India's external vulnerability
Short-term debt and long-term debt due in the next one year are on the rise. As per the Reserve Bank of India (RBI) figures, this has increased to $172 billion in March 2013, up from $147 billion a year ago.
Excluding NRI deposits, short-term residual maturity debt amounts to a massive 42% of total forex reserves. While this is not as alarming as the early nineties, Nomura notes that it is indeed a steep rise from a low of 16% in 2004.
While debt capital inflows help finance the current account deficit, they could also worsen the balance of payments situation. According to Nomura, with global risks on the rise, difficulty in rolling over debt could put pressure on net capital inflows, thus leaving the currency vulnerable.
With great fanfare the mutual fund industry announced CRISIL-AMFI Equity Fund Performance Index yesterday, which is claimed to give an annualised return of 22%. However, a simple check shows that there were 25 equity schemes in April 1997 (that have survived) and only six have delivered a return above 22%. The average return of all equity schemes was 17%
At the Mutual Fund Summit 2013 organised by the Confederation of the Indian Industry (CII), CRISIL and the Association of Mutual Funds in India (AMFI) jointly launched a family of mutual fund performance indices across all categories. As per the report titled CRISIL-AMFI Mutual Fund Performance Insights, “These indices, the first of their kind in the country, represent the performance of various mutual fund categories and enable comparison of these categories with appropriate benchmarks across time frames and market cycles.” Out of the five main categories, the CRISIL-AMFI Equity Fund Performance Index is claimed to have delivered an annualised return of 22% since 1 April 1997, as compared to annualised returns of 12% and 13% by the benchmarks CNX NIFTY and CNX 500, respectively during the same period.
The report does not mention a word about the methodology. Since 22% appeared to be a very high average number, Moneylife decided to analyse the performance of equity diversified schemes over this period. To our surprise we found out that there were 25 schemes launched prior to 1 April 1997 which are still in existence. Out of these schemes there were just six schemes which delivered returns greater than 22%. The average return of the schemes was 17% with the top five schemes delivering an average return of 26% and the bottom five schemes delivering a return of 7.18%. CRISIL-AMFI Equity Fund Performance Index looks grossly flawed.
Of course, our data is biased in favour of survivors. If we want to free it from survivorship bias, the 17% figure will drop down drastically because we will have to include the dregs of fund list which have been closed and merged.
The report mentions that the indices are constructed using schemes that are ranked by CRISIL under its quarterly mutual fund rankings. The indices are meant to reflect the performance of funds at an aggregate level. Has the Crisil-AMFI index been adjusted for ‘non-surviving’ mutual fund houses? Fund houses like those of PNB Mutual Fund, Alliance Capital Mutual Fund, BOI Mutual Fund and BOB Mutual Fund have failed to continue their business. How does the index adjust for the performance of the schemes of such fund houses or even schemes of present fund houses which get merged with other schemes?
Moneylife sent an email to AMFI and CRISIL to learn more about their methodology for calculating the index, however, no reply was received till the time of publishing this article.
Roopa Kudva, managing director and chief executive officer, CRISIL, at the launch said “Retail investors can use these indices as a standard performance metrics to understand the benefits of investing through mutual funds.” However, if retail investors were to follow this index, it would give them a flawed judgement of performance. The performance analysis, that too, from reputed institutions.
Disclaimer: All our mutual fund analysis is based on the data purchased from Mutual Funds India database of ICRA Online. While the analysis is our own, we cannot guarantee that Mutual Funds India has reported the data correctly.