What a wonderful world: This is 2018 - companies are borrowing at 8.5 %, home buyers get loans are at 9.5% and the Sensex is hovering at 32,500

For the Sensex to be higher significantly some problems that may convert into shocks must abate or India must contain them

Is it realistic to expect the RBI to achieve 4% inflation by end March 2018?  I believe the answer is yes. Why? Here I quote from my last blog:

“Demand conditions in India are weak: capacity utilisation is estimated at 70-72%. The world has suffered a commodity shock, and commodity prices are expected to remain soft. World demand is also very weak.”

Plus the RBI has the right monetary stance – an accommodative monetary policy with real rates under close watch.

In two years, India’s economy will be growing faster – but not likely at a superhot pace, by which I mean a return to the pre 2008 financial crisis growth rate of 9%.  Given the environment as stated above, it is unlikely to create inflationary pressures.

In my last blog I had put forward my projections for the repo rate by end March 2017 and 2018 assuming the RBI achieves its interim and final target for inflation. I reproduce those projections along with ballpark projections of the base rate, one year fixed deposit rate and home loans. The rates today are also below for readers to get a picture of the change that could take place over the next two years.

So in two years’ time, a depositor could be receiving about 6.5% on a one year deposit – about 1.25% less than today.  Businesses should be able to borrow cheaper by 1.5% at about the 8.5% level. Families looking at buying a house could take out home loans about 1% lower in the region of 9.5%.

On balance, we could then be entering a virtuous cycle, with lower rates all round giving another boost to the economy.

It definitely looks like a more cheerful world, but for the depositor. Will depositors move their money into stocks and bonds (via mutual funds)?

Markets typically move in advance of events. Barring a shock – China or emerging market debt or unanticipated Federal Reserve tightening - I feel that savers should take this opportunity to judiciously shift some of their savings to equities – either using an index or picking stocks of companies with strong brands, steady profits, and sustainable competitive advantages.

Equities normally react positively to rate cuts by the central bank. Equity markets have not responded to the already 1.25% cut in RBI’s repo rate, but as the cloud clears on the Indian economy and some of the international uncertainties abate, they will. As investors anticipate another 1% cut by the RBI over the next two years, equity markets could move up significantly higher. A 30% rise in the Sensex over the next two years is a good possibility.

Long term bonds – treasuries – are also likely to give good returns. The price of a bond rises when yield (rate of interest) falls.  In anticipation of a fall in the repo rate, the 10 year treasury bond yield could fall by 1% to about 6.5%. This could lead to total return (price plus coupon) in excess of 20% over the next two years.

On property, I am not so positive. Data on Indian property indices come with considerable lag, so it is difficult to get a good picture on property.  Most places that I visit, I sense that there is considerable property inventory in stock. Of course, this would not apply to a specific location, where some special factors may create an attractive investment opportunity.