Over the last year or so, the Reserve Bank of India has repeatedly increased two things:
- Rates at which banks can borrow money from it: this is popularly referred as the 'repo rates.'
- Curbing liquidity by increasing CRR (Cash Reserve Ratio, that is, the portion out of the deposits raised by banks, that must be kept with RBI).
The net effect: increase in the interest rates by the banks.
This means that the industry and the consumers, i.e. you, have to pay higher interest rates on loans, even though the aim is to:
- Curb inflation; and
- Reduce asset prices, especially the real estate, to more realistic levels.
Indian companies have strong balance sheets, built-up since liberalisation began in 1991. They can absorb the high interest rates, but only to an extent. Beyond a certain point it will hurt their profitability.
Also, as consumers find it expensive to borrow, there is going to be some cooling down of the demand too. Add to this, international factors like slowing down US economy, high oil prices, standoff between Iran and the United States, etc. This is likely to affect both 'the overall growth' and 'profitability.'
Moderate growth with low inflation is considered to be good for sustained long-term economic progress vis-à-vis an unrestricted high growth with high inflation. Therefore, in the long term the measures taken by RBI may turn out to be beneficial for the economy.
But it is a matter of debate whether this kind of intervention by RBI will really achieve its purpose, given the fact that inflation in India is mainly on account of 'supply constraints' and 'increased money supply as RBI buys the dollars coming in, which increase the rupee supply into the economic system.' But that's a matter of separate discussion.
Coming back to impact of high interest rates on growth and profitability. The whole basis of a buoyant stock market is 'profitability' and 'growth.' So in the short term there is likely to be some effect on stock markets. Further, people who used to borrow cheap money and invest in stock markets will reduce such deals as borrowing money becomes expensive.
Going forward, one may see some correction and maybe a six-month to one-year period of low returns. Also, the markets have a tendency to swing from a phase of irrational exuberance to one of excessive pessimism. Therefore the markets are likely to test the patience of many investors.
However, if India can ride out, what appears to be a small bump on a road of long-term growth, one may still make good money out of equity.
But three things are important:
- Have moderate return expectations: The days of 40-50 per cent p.a. returns are gone.
- Keep a long-term investment horizon: Not less than 3-5 years.
- Invest systematically every month: Lower market levels offer a good opportunity to buy cheap.
The confident mood of the Indian business community, the strong and fairly insulated economy and favourable demographic profiles are some factors that still inspire confidence in that the economic growth may only slow down a bit, but not derail completely.
Moreover in the last 15-20 years, the average return from equity was about 16 per cent p.a. Today, Indian companies and the economy are in a much better shape than ever before in the last two decades.
Also, the average disposable income of a consumer is much higher. Therefore, it may not be unreasonable to expect at least the same kind of returns over the next 5-10 years, if not somewhat better.
But as mentioned earlier, given the scenario that is likely to pan out, one may witness some tough times ahead. The days of making easy money may be over.
If one is patient and discerning enough, though, there's still a lot of money to be made off the markets.
Meanwhile, let's hope that high interest rates reduce fast for better gains.
The author is an investment advisor.
