RBI Policy Archives

RBI’s unexpected rate hike shakes the interest rate landscape

The twin moves, which shocked markets, will have implications for fixed income products

On a day the LIC IPO opened to collect a record Rs 21,000 crore for the government, the central bank’s monetary policy committee (MPC) threw a surprise and raised the key lending rate by 40 basis points citing persistent inflationary pressures. This is the first rate hike since 2018. To add salt to wounded stock markets, MPC also raised cash reserve ratio by 50 basis points to 4.5 per cent. Together, the rate as well as CRR hike, translate to a massive anti-inflation fight by the country’s banking regulator, but the moves will mean higher interest rates for the economy, which was coming to normalcy after the crippling effects of Covid pandemic for more than two years. Do note the RBI rate hike moves comes ahead of anticipated moves by the US Fed to hike rates there.

Monetary impact
The surprise rate hike by the RBI comes at a time when there was a feeling that the India central bank is falling behind the curve. Todayâ€™s rate hike makes the effective rate higher by 80 bps. The simultaneous 50 bps CRR hike would tighten liquidity by an estimated Rs 90,000 crore immediately. This would improve the transmission of rate hike in credit and debt market.

One can expect immediate increase in money market rate, some transmission in the long-term bond market and also credit market.

Debt funds impact
With the formal initiation of monetary policy tightening, there could be more rate hikes in the offing, alongside durable absorption of systemic liquidity.

An immediate hike in June probably may materialise and it is challenging to call out the final rate against the current uncertain global macro backdrop. Many foresee an additional 35-60 bps of rate hikes in the remainder of H1 FY2023.

The 10 Year G-sec shot by ~20bps to 7.40 per cent in an immediate response to the policy announcement.

Debt investors will lose out when interest rates go up, as the net asset value (NAV) of debt funds decline. When interest rates rise, prices of fixed income securities fall. This leads to a decline in the NAV of fixed income funds that hold these securities in their portfolio.

Interest rates are expected to go up but gradually. In such a scenario, investing in roll down funds up to 3-year maturity make sense.

The higher the average maturity of the fund, the higher is the impact of rising rate. So, one should avoid locking their investment in long term debt funds at this moment.

Effect on equity markets
Equity markets went into bloodbath post hikes since itâ€™s a double whammy for companies. First, increasing costs across inputs and two, rising interest rates.

The impact of rate hikes on the equity market is likely to be negative in the short-term. The Sensex fell by 1200 points or over 2.2 per cent to 55,710.38 on Wednesday. Higher interest rates will be particularly negative for leveraged firms, whose interest costs will rise, thus impacting their bottom line.
For equities, oil price and inflation are key monitorables now. Any rise in these two can further upset the interest rate situation, and mark a top for equity markets that have rallied for most of the years since 2014.

Cheap home loan era ends
Inflation has been edging higher in the aftermath of the Russia-Ukraine war and the surging oil prices. The only way to fight rising prices is by hiking interest rates. This is precisely what the RBI under Governor Shaktikanta Das has now done.

Unfortunately, for home buyers, this rate hike signals an imminent end to the all-time low interest regime, which has been one of the major drivers behind home sales across the country since the pandemic began.

This rise in interest rates will ultimately impact overall acquisition cost for homebuyers – and may dampen residential sales to some extent.

We had already started seeing transmission of interest rates but since most of the loans are linked to repo we may see impact on corporate and retail credit soon.

RBI holds rates steady: What should debt fund, fixed income investors do

The first bi-monthly monetary policy for fiscal 2022 kept a status quo on all key policy rates. The Monetary Policy Committee (MPC) of the RBI also reiterated an â€œaccommodative stanceâ€ on rates and â€œsurplus liquidityâ€ to help the economy return to a durable growth path. In this backdrop, what should fixed income and debt fund investors do? Here is a low-down.
Positive for long end tenor
Key measures include a quarter wise OMO calendar, that should help manage the yield curve and the massive borrowing program, with INR 1 trillion scheduled in Q1-FY 22. RBI expects inflation to rise marginally in FY 22 though expects food inflation to soften. “The policy is supportive of long end rates, with some impact at the shorter end owing to longer tenor liquidity absorptions as part of the liquidity management program. We would continue focusing on Banking & PSU, Corporate Bond and Dynamic Bond fund categories, post todayâ€™s policy, ” says Kumaresh Ramakrishnan, CIO-Fixed Income, PGIM India Mutual Fund.
Corp bond spreads remain moderate
Interest rates are likely to remain range bound going forward as RBI is committed to ensure easy liquidity and low repo rates. The increase in Government borrowings are likely to be partially offset by RBI OMOs and secondary market purchases of Government securities. Inclusion of government securities global bond indices will add to the demand.
“Corporate bond spreads are likely to remain at moderate levels on back of restrained supply and continued demand from institutional investors. Unless inflation expectations start increasing in the future, fixed income investors will do well to remain invested in Indian bonds,” says Sandeep Bagla, CEO, TRUST Mutual Fund.
Dynamic for higher risk takers
RBI’s concerns over inflation was clearly reflected in the governor’s statement. This along with the fact that the RBI has given up on the time based forward guidance to keep monetary policy accommodative, indicate that course of monetary policy could change sooner than expected.
Says Pankaj Pathak – Fund Manager – Fixed Income, Quantum Mutual Fund: “We expect that the RBI could start hiking policy rates towards end of this year. On the other hand the commitment to buy government bond under the GSAP is a good move to support the long term bond yield. this will support long term bond yields in near term. But medium term trajectory will depend more on the policy outlook.”
Pathak feels investors should expect gradual rise in bond yields over medium term We also expect very high volatility in interest rate going forward, he added.
Dynamic bond funds could be an option for investors with long time horizon and higher risk appetite. Conservative investors should stick to liquid funds.

Low single-digit returns

“Todayâ€™s RBI policy has reiterated our earlier view that investors should expect low single-digit return from the bond market in FY22 and will have to increase their average maturity in order to optimize their risk-adjusted returns. We wish to highlight that investors at the short-end (up to 2Y) will probably earn
zero or negative real return (inflation-adjusted) in FY22, similar to FY21,” says Dhawal Dalal, CIO-Fixed Income, Edelweiss Asset Management.

Prudent investors are requested to consider investing in high-quality bonds maturing in 5Y or higher through passively-managed target-maturity bond index funds as well as bond ETFs to benefit from diversification, transparency, simple & clear investment objectives and predictability of returns for hold-to-maturity investors in our opinion, Dhawal added.

The move to introduce G-SAP â€“ secondary market GSec acquisition program is a master stroke by the RBI, said many experts. This would reign in sharp spike in GSec bond yields. Introduction of long term VRRR (variable rate reverse repo) is an extension towards normalising liquidity. “Liquidity surplus however will and is likely continue. We expect yield curve to flatten from the current levels with the longer end of the yield curve compressing faster than the short end,” says Lakshmi Iyer, CIO (Debt) & Head Products, Kotak Mutual Fund.

“…with these measures, RBI measures should be able to counter the global adverse backdrop of upward movement in yields and higher commodity prices. The increase in Long term repo operations over 15 days could see the upto one year yields moving up by 10 to 15 basis points and remaining at that level,” feels Murthy Nagarajan, Head-Fixed Income, Tata Mutual Fund.

RBI keeps rate unchanged, to boost liquidity

The RBI has kept the repo rate unchanged at 4% while maintaining its accommodative policy stance. The Monetary Policy Committee (MPC) of the RBI voted unanimously in favour of keeping the policy repo rate unchanged for the second consecutive time. The RBI also continued with its accommodative policy stance and mentioned that it would maintain the stance for as long as necessary to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target range going forward.

The central bank expects real GDP to contract by 9.5% in FY21, with risks tilted to the downside.

The highlights of the policy are below:

1. Policy measures – Repo rate kept unchanged at 4%.

2. GDP – Real GDP expected to contract by 9.5% in FY21, with risks tilted to the downside.

3. Inflation – Decided to view the high current inflation as transient owing to supply disruptions caused by the COVID-19 pandemic and focus on reviving growth. Upside risks to inflation may be mitigated by a normal monsoon, arrival of new crops, and the base effect.

4. Stance – RBI continued with its accommodative policy stance. It proposes to maintain the stance as long as necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target range.

5. Other measures
–RBI to conduct on tap Targeted Long Term Repo Operation (TLTRO) with tenors upto 3 years for a total amount upto INR 1 trillion at a floating rate linked to the policy repo rate. The scheme will be available upto March 31, 2021.
–Investments made by banks under this facility will be classified as ‘Held to Maturity’ (HTM) even if such investments exceed the permissible limit of 25%.

6. Outlook
–Lower inflation will provide headroom to the RBI for continuing with the accommodative stance.
–The short to medium segment of the curve is attractive due to relatively lower supply in H2 borrowing and relatively attractive valuation.
–RBI highlighted that while there is space for rate cuts, it would like to use this space more judiciously. The future rate actions to hinge upon relevant incoming data.

Post the announcement, the market turned bullish and yields softened by 7-10 bps across the yield curve. The RBI assured market participants that it will continue to maintain comfortable liquidity conditions and conduct market operations in the form of outright and special OMOs. The size of these auctions has doubled to INR 200 billion which may aid bond market sentiments. Further, the announcement on OMO purchases of SDLs is likely to help alleviate supply pressures. Post this announcement, the SDL yields were down by 12-15bps.

The RBI expects real GDP growth in FY21 to be at – 9.5%, with risks tilted to the downside; For Q2FY21, it expects GDP to grow at -9.8%, for Q3FY21 at – 5.6%, and for Q4FY21 at 0.5%. It expects Q1FY22 real GDP growth at 20.6%. The RBI indicated that increased government spending, good rural demand, and robust outlook for agriculture sector augur well for the economy.

On the inflation outlook, the RBI indicated that while supply-chain disruptions are likely to dissipate, aggregate demand is likely to stay subdued. The MPC has decided to view the high current inflation as transient owing to supply disruptions caused by COVID-19 pandemic and focus on reviving growth. The RBI also mentioned that upside risks to inflation may be mitigated by a normal monsoon, arrival of new crops, and due to base effect. Lower inflation will provide headroom to the RBI for continuing with the accommodative stance.

The RBI is focused on ensuring a non-disruptive borrowing program. Scaling up the size of OMOs, introducing on-tap TLTROs, extending HTM limits for banks, and introducing OMOs in SDLs are all steps that are aimed at alleviating funding pressures across the economy. In absence of a calendar for OMOs, market may expect the RBI to use OMOs tactically, as and when the need arises. The short to medium segment of the curve is attractive due to relatively lower supply in the H2 borrowing and relatively attractive valuation. The RBI highlighted that while there is still space for further rate cuts, it would like to use this space more judiciously. Future rate actions by the RBI to hinge upon relevant incoming data.

Source: Excerpts from a note on RBI policy by Franklin Templeton.

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The highlights of the policy are below:

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