The Monetary Policy Committee (MPC) decided to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 6.0 percent from 6.25 percent. Consequently, the reverse repo rate under the LAF stands adjusted to 5.75 percent, and the marginal standing facility (MSF) rate and the Bank Rate to 6.25 percent.
One basis point is a hundredth of a percentage point.
The MPC also decided to maintain the neutral monetary policy stance. There were some sections of the market expecting a 50 bps cut in rate given the current benign global conditions. However, the RBI chose to take baby steps rather than a bold one – which seems appropriate.
Also read: Nilesh Shah, CEO, Kotak Mahindra AMC's take on RBI MPC
This move seems largely in line with our and market expectations. The RBI also seems concerned on the likely impact of global slowdown on domestic growth. In line with this thought, the RBI has revised the GDP (Gross Domestic Product) growth outlook for FY 2020 from 7.4 percent to 7.20 percent.
The Consumer Price Index (CPI) inflation forecast also has been lowered to 2.9-3.0 percent in H1:2019-20 and 3.5-3.8 percent in H2-2019-20, with risks, broadly balanced. The bond markets had already baked in such an outcome and hence the response post policy was quite tepid.
Another key factor influencing markets is the liquidity in the banking system. The RBI had announced a $5 billion forex swap wherein banks would get rupee in lieu of swapping dollar with the RBI for a period of three years. This, we believe is a masterstroke from a liquidity injection perspective and such continued measures would certainly augur well for the fixed income markets.
Additionally, with a view to move further towards harmonisation of the effective liquidity requirements of banks with the LCR (liquidity coverage ratio), the RBI decided to permit banks to reckon an additional 2 percent of government securities within the mandatory SLR requirement. This to an extent will help better liquidity at banks. It also could address the transmission concerns, which continues to be the centre point of debate at all times.
While bond yields especially corporate bond yields have been easing, the government bond yields haven’t kept pace. This is largely due to concerns emanating on the fiscal side – whether the government would really toe the line of fiscal discipline. Given the rate cut, as the carry looks attractive, we do see some support coming in for government bonds at higher yields.
While foreign investors continue to be net sellers in India debt CY 2109 year to date (Rs 6,000 crore), the sentiment seems to have changed a tad for the positive. Going forward, the general elections in India would assume significance and markets would continue to watch out for cues emanating thereof. As such, India fixed income yields currently are offering a compelling carry to be availed of by domestic and foreign investors alike.
How Should Investors React To This And Plan Their Investments?
For an investor, it is important to track such events, but not really base an investment decision entirely on such outcomes. Here in comes the role of appropriate asset allocation. Cliché as it may sound, that’s what finally matters when it comes to wealth creation. Given the current interest rate scenario, one could look at core allocations to a combination of short and medium duration funds with tail end allocation to credit risk and long duration funds. Important is to stay the course.
Lakshmi Iyer is Chief Investment Officer of Debt and Head of Products at Kotak Mahindra AMC