As I've sat down to write this, a wave of optimism is sweeping across markets. The reason, of course, is that a few days ago, RBI governor Dr Raghuram Rajan has lowered the policy rate by 0.25 per cent. With this, a turning point has been reached in Rajan's battle against inflation. By reducing interest rates earlier than when most expected, Rajan has clearly indicated that he believes inflation to be on its way to being tamed. Or does he? Couldn't it equally be said that while inflation is still a problem, the lack of growth is now a bigger problem? Well, let me not be a party pooper.
Let's stick to the more acceptable and optimistic view that we've tamed inflation and now we are turning our full attention to growth. Of course, for some years now, the economic discourse in India has focused too much on interest rates. So much so that for an investor who is learning about economics from news articles (as most do), interest rates might appear to be the be all and end all of factors that drive growth. Part of the blame goes to the previous finance minister, P. Chidambaram, who often tried to lay the blame for declining growth at the RBI's door by pointing at high rates. It was a story that too many people swallowed and started thinking of interest cost as the sole driver of business performance and economic growth.
Let's be clear that the actual quantum of interest rate reduction that Rajan has delivered at this point will not make or break anyone's business. For example, a heavily indebted infrastructure company would find a reduction of ₹50 crore of interest outgo for ₹10,000 crore of debt. It's just a drop in the ocean, even if we assume that the borrower will immediately be able to actually benefit (highly unlikely) from the reduction. At the other end, for a small/medium enterprise (SME) with ₹20 crore of debt, the equivalent number is ₹5 lakh a year-again hardly worth getting excited about.
Even so, equity markets are justified in their excitement. The reason is the context of this interest rate reduction. One, it implies a change in direction of interest rates. Over the next three or four years, we could see a cumulative reduction of 2 to 4 per cent, which will be significant. This will encourage businesses to invest, which by itself will further boost growth. Secondly, the implied taming of inflation will by itself encourage growth by protecting real incomes, whether to be used for savings or for expenditure. Thirdly, the repair of government finances damaged during the UPA decade has a better chance of succeeding.
And lastly, a similar virtuous cycle will come into being for equity investments. However, herein lies the problem. While everyone's happy that equities are going to be making gains that are long overdue, we at Value Research take a more circumspect view. I mean, like everyone else, we're happy too but we're also wary. Our final interest is in our readers finally making more money, not in the numbers going up. Unfortunately, past experience has shown that in phases like this-when markets are obviously headed up-investors make poor-quality investments. The incoming tide raises all boats and it's hard to see which ones will keep floating and which ones will eventually sink.
It's a time to be excited, sure. We are all excited about India's future. But it's also a time to invest carefully in quality stocks for the long term.
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