Stock market pundits are betting on a repo rate cut of 0.25-0.50% on April 17, when the Reserve Bank of India reviews its monetary policy. Repo rate is the rate at which the Reserve Bank of India lends money to banks. Naturally, all eyes are on the stocks in the interest rate sensitive sectors such as infrastructure, banking, housing finance and automobiles, which have been beaten badly on the bourses for sometime now. For example, in the last one year the Bankex and CNX Infrastructure indices are down by 12.73% and 22.29%, respectively, compared with the Nifty which is down only 9.66%. Arguably, a change in the interest rate scenario could definitely alter the fortunes of these sectors. "Investors should increase their allocation to the interest rate sensitive sectors gradually. These sectors could constitute about 30% of your overall portfolio," says Madhumita Ghosh, senior VP (research), Unicon Financial Intermediaries.
That may sound a great strategy. Many traders have already taken bets on some stocks in these sectors expecting a rate cut, as the central bank has already cut CRR by 1.25% since January this year. Several stocks in the infrastructure and banking space have moved upwards during the past three months. For example, State Bank of India (SBI) has moved up from . 1,630 in January to . 2,210, a run-up of 39%. Similarly, IRB Infra has moved up from . 126.40 to . 187 a gain of 53% during the same period. But the question is whether a minor reduction in the policy rate will have a lasting impact on them, forcing investors to have a serious look at these sectors and weak stocks in their universe? The question is even more pertinent because many banking experts believe that it will be a while before the central bank may actually unwind its tight policy regime. "At the moment, we expect only a 25-50 basis points cut, after which the central bank will pause. It will then take a look at inflation, economic growth rate, crude oil prices before deciding its next course of action," says Dipen Shah, head of fundamental research at Kotak Securities.
DON'T EXPECT MIRACLES
"A small drop of 25 basis points alone may not be enough to make these sectors a great pick. One has to be sure that we are in a falling interest rate environment, and more cuts are likely in the near future to make these sectors attractive," says Abhishek Jain, head of research at JHP Securities. That sums the key to investing in sectors expecting a policy change. While experts may have varying views — which is always the case when it comes to taking such calls — you need to make a decision after taking into account your investment horizon and goals. For instance, if you are an investor with an investment horizon of two to three years, the long-term outlook for these sectors is bright. "With the economy expected to grow by 7-8%, one needs good infrastructure in the form of roads, power, ports, etc to support this growth, thereby pointing to a bright future for the infra sector. Similarly, high economic growth will present multiple opportunities for banks to grow in both corporate as well as retail spaces," says Sadanand Shetty, vice president and senior fund manager, Taurus Mutual Fund.
INFRASTRUCTURE STOCKS WILL
BENEFIT THE MOST
One of the major reasons for poor performance from the infrastructure segment over the last couple of years has been the continuous rise in interest rates. Since infrastructure companies have a high debt component on their balance sheets, high interest rates reduced returns from such projects and even made many of them unviable. "Most infrastructure companies are highly leveraged. On an average, if a project costs . 100, . 75 is funded through debt and the balance . 25 comes in through equity. If interest rates fall by 1%, it could bring down the interest cost of infrastructure companies by 8-9%," says Gaurang Vasani, executive director, Strategic Growth Advisors.
TWIN BENEFITS FOR BANKING
Besides the overall increase in economic activity on account of lower interest rates, which will benefit the banks, there are a couple of other reasons why they will benefit more. "Bond portfolio of a bank benefits in a falling interest rate scenario," says Dipen Shah. When interest rates fall, bond prices rise, which in turn could give banks a capital appreciation on their bond portfolios, thereby increasing their treasury income. So, if the interest rate drops by 50 basis points, a 5-year bond could see a capital gain of approximately 2-3%.
Public sector banks will benefit on another front, where the percentage of restructured assets as a percentage of total advances is high. Take the case of the Punjab National Bank. Restructured loans as a percentage of advances are as high as 6.4%. For the Central Bank of India, it is even higher at 7.4%. "Once the interest rate cycle reverses, restructuring of loans will go down, thereby improving profitability of banks. Thus restructured assets of banks will peak out faster," says Kartik Mehta, AVP (research), Sushil Finance.
Housing finance and automobile companies, like LIC Housing Finance and Maruti, could also be beneficiaries of a rate cut, as it could lead to higher consumer demand. Similarly, automobile companies could gain due to higher demand for passenger vehicles. "A decrease in interest rates could lead to increase in demand for home and auto loans," says Vijay Kedia, managing director, Kedia Securities.
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