The RBI governor has been hesitant in cutting interest rates partly due to inflation scare and partly because the transmission of interest rate cuts hasn’t happened through banks. With retail inflation now sub-4% and wholesale inflation in negative territory, the governor has still sighted inflation as his primary concern, which is not completely misplaced considering the high prices of select cereals and more recently onions. Considering the fact that there is very little RBI can do to control prices of individual commodities it is still a reality that supply side inflation in India has often been a cause (albeit erroneously) for holding interest rates too high for too long. Rajan in this respect has not been very different from his predecessors and has always preferred to err on the side of caution.Though looking at the recent retail and wholesale inflation numbers and the price movement in crude oil,it seems a deflationary scenario is also not too far away. Countries which struggled with deflation and keynesian economists have always preferred some inflation over deflation, and often equate deflation with doom. But for a country like India which is basically a commodity consumer short term deflation might actually prove to be a blessing in disguise and certainly not a major threat considering the amount of ammunition (in terms of possible interest rate cuts) in hand.
The prospect of US Fed rate hike in September has played its role in dampening the case for rate cuts on the pretext of possible flight of capital and subsequent effect on INR. The currency devaluation move by China has effectively started a currency war (which is only in its initial stages) and the asian currencies have been first in the line of fire to suffer. But such a currency devaluation has only strengthened the case for a rate cut as it has made it more difficult for Fed to go ahead with a rate hike specially after the current crack in the US stock markets, which effectively is the only parameter they look at, though they would never say so. Also the Chinese currency devaluation move has given RBI the leeway to let INR depreciate without their interference (although we do note the verbal intervention by Rajan whereby he pointed out that our currency reserves may be used to defend INR if needed).
Looking at how the currency, interest rate and inflation scenario is unfolding around the world, there is a rock solid case for further rate cuts (and at a faster pace than just 25 bps cut), what is more this has been the case since july of 2014 and this has been substantiated only to an extent by 3 rate cuts from RBI. If one were to look at return from debt funds over the period (specially ones with longer duration) one will be surprised to see return of 12-15% in most of them, thus outperforming even sensex and nifty. What is more it is very likely that such outperformance is likely to continue over the next year, even if sensex and nifty reach their all time highs. It would be prudent for investors to start looking at debt funds more seriously and choose funds with high duration (ones owning long tenured bonds). Duration of a fund is stated by the respective mutual fund for all their funds and one just needs to choose a long term debt fund with highest duration to benefit most from persistent interest rate cuts.
