Impact 
After the S&P (credit rating agency) recently downgraded the U.S.'s sovereign credit rating to "AA+" with a negative outlook (from prime ratings of "AAA"), the Reserve Bank of India (RBI) is re-thinking on its policy of investing only in AAA rated sovereign bonds.
At present there is no written rule that only "AAA" papers will be bought, but as a matter of prudence, the RBI forex management committee follows this principle. So far the RBI has consistently turned down suggestions for enhancing returns on the country’s forex by buying lower-rated bonds that offer relatively higher return, at a higher risk.
Thus far present policy measures taken by RBI have been a saviour. Moreover, with the central bank holding $25.34 billion in gold (comprising about 8% of reserves) has enunciated the precious yellow metals trait of being a safe haven, and has hedged our countries position to such a risk.
(Source :ACE MF, PersonalFN Research)
Also India’s forex investments are fairly diversified as compared to other nations. Currently India’s investments in US Treasury bonds constitute about 13% of its total forex reserves which stood at $319.09 billion (as on July 29, 2011), while that of China is at 36% of its $1.1 trillion forex reserves in the U.S. treasury.
Thus given the prudence adopted by RBI through its policies, we believe that the present approach of buying "AAA" papers is rather balanced and does not expose our country to dominant risk (due to a well-diversified portfolio), and thus should not be tampered with. Moreover, the approach of aggressively buying gold from time to time also hedges the risk for our nation.
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Impact 
The global turmoil led by downgrading of the coveted US debt ‘AAA’ rating by S&P credit rating agency and the persistent fears of default by European nations like Spain, Italy triggered bloodshed in the equity markets throughout the world. The BSE Sensex too corrected by a good 18% since its pervious high of 21,004.96 on November 5, 2010. Thus assuming that the negative sentiments could lead to redemptions under mutual fund schemes, the Indian fund managers are increasing their cash holdings in equity schemes.
| Mutual Fund houses |
Total Equity AUM |
Cash as a % of AUM under Equity schemes |
| Reliance Mutual Fund |
32,006.5 |
4.5 |
| HDFC Mutual Fund |
30,434.0 |
3.6 |
| UTI Mutual Fund |
21,561.2 |
6.4 |
| SBI Mutual Fund |
16,217.2 |
6.3 |
| ICICI Prudential Mutual Fund |
14,459.9 |
9.8 |
| Franklin Templeton Mutual Fund |
13,831.7 |
7.2 |
| DSP BlackRock Mutual Fund |
11,874.5 |
4.7 |
| Birla Sunlife Mutual Fund |
10,823.1 |
6.8 |
| Sundaram Mutual Fund |
8,557.8 |
8.2 |
| Fidelity Mutual Fund |
6,372.8 |
6.1 |
(Source :ACE MF, PersonalFN Research)
From the above table, the top 10 fund houses (based on their AUM) are seen piling up cash anywhere about 4% to 10% of their equity schemes AUM.
In our opinion such an approach adopted by the respective fund house is very prudent, as this would enable in better handling of redemption pressures, and also provide the fund managers opportunity to do some "value buying" at these well corrective phases of the Indian equity markets where valuations are appearing reasonable. We believe that such a defensive stance adopted by most fund houses would in the long-term interest of wealth creation for investors. |
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Impact
 Now Qualified Foreign Investors (QFIs) can invest upto U.S. $3 billion in debt schemes that invest in corporate bonds of infrastructure companies. Recently - in the week gone by, the capital market regulator - SEBI (Securities and Exchange Board of India) in consultation with the Government and RBI allowed foreign investors (termed as QFIs) who meet KYC requirements, to invest upto U.S. $3 billion in infrastructure focused debt funds. However, while doing so the capital market regulator has notified that the infrastructure bonds should have a residual maturity of at least five years. Simultaneously, the regulator also put out rules for such investors to buy directly in equity-based mutual funds for which a U.S. $10-billion limit has been fixed (a promise made in this year's budget).
However, it is noteworthy that the QFI limit for debt will be within the overall ceiling of U.S. $25 billion, including FIIs, set by the central bank for corporate debt issued by infrastructure firms. Moreover, so far only FIIs and NRIs were allowed to buy units of domestic MFs.
We believe that such a move of allowing QFIs to invest in India, would improve the depth of our bond markets, and attract long-term foreign fund flows which would benefit the infrastructure development in India. We also think, it would entice QFI’s to invest in India as at present the interest rates in the developed economies are very low (or even close to zero), as compared to India, where they may shift their focus here to obtain a better return on long-term investment. Moreover, stable rating provided by most rating agencies may encourage them to invest in our country. |
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| Weekly Facts |
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Close |
Change |
%Change |
| BSE Sensex* |
16839.63 |
(466.2) |
-2.69% |
| Re/US$ |
45.41 |
(0.9) |
-1.93% |
Gold /10g |
26,195.00 |
26,195.00  |
9.03% |
| Crude ($/barrel) |
105.36 |
(7.6) |
-6.72% |
| FD Rates (1-Yr) |
7.25% - 9.25% |
Weekly change as on August 11, 2011
*BSE Sensex as on August 12, 2011
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In this issue
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In an interview with the Economic Times, Dr. Y.V. Reddy, Former Governor of the Reserve Bank of India (RBI) shared his views on strategy to be followed by India in the times of a debt crisis and diversification of currency reserves by India.
Dr. Reddy believes that the challenge for India is to start thinking in terms of a nimble strategy, not just cautious policy to handle a divergent world. He further explains - "First is to have a strategy, second is to be nimble. The next question is how are the other emerging markets going to do is an issue. Most other EMEs (Emerging Market Economies), particularly in Asia, are stronger than India. Then our fiscal is weak. In the past 2-3 years, the quality of the fiscal deteriorated. Other countries did a stimulus that could be withdrawn; we did a stimulus which is not easy to withdraw. They did the stimulus on the investment side; we had a stimulus on the consumption side. Compared to other EMEs, we are weaker on the fiscal. We have to be watchful even in the external sector for two reasons. In this type of situation of commodity prices, especially food and energy, we are vulnerable on both sides (fiscal and external) more than other countries. Many other EMEs have an advantage in the commodities sector. We don't have that advantage."
On the diversification of currency reserves front Dr. Reddy is of the view diversification into other currencies is not done in reacting to something. He explains his stance by saying that, "They are two different things (buying gold or other currencies). The case in favour of gold was always made by Mr. Tarapore. But the general principle was that one should not get into it. There was a philosophical problem of not being active in gold. The whole world knew there were uncertainties."
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Bond Rating: A grade given to bonds that indicates their credit quality. Private independent rating services such as Standard & Poor's, Moody's and Fitch provide these evaluations of a bond issuer's financial strength, or its the ability to pay a bond's principal and interest in a timely fashion.
(Source: Investopedia)
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QUOTE OF THE WEEK
"Value is not intrinsic; it is not in things. It is within us; it is the way in which man reacts to the conditions of his environment."
-Ludwig von Mises
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