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In an effort to curb inflation, RBI has increased repo rate by 40bps and cash reserve ratio (CRR) by 50 bps on Wednesday. With this, repo rate now stands at 4.40% and CRR at 4.50%.
Repo rate is the rate at which RBI lends money to banks while CRR is the rate on deposits which banks have to maintain with RBI.
In simple terms, if repo rate increases, banks have to pay more money to RBI in the form of interest which sucks liquidity from the banking system. Further, banks have to keep deposit with RBI to maintain CRR level and this money, lies idle with RBI; thereby, tightening the liquidity further. Both these measures aims to curb inflation but, in the process, bond yields go up sharply and returns from debt funds decline.
Debt Guru Joydeep Sen believes that rate hike was expected. “Nothing has changed fundamentally. We knew RBI would increase repo rates sooner or later. And debt markets have already factored in this hike.”
Sen recommends that MFDs should simply recommend target maturity funds as these funds negate the impact of rate hikes if held till maturity. For investors with short time horizon, MFDs should go with low duration funds.
Rajeev Radhakrishnan, CIO-Fixed Income, SBI Mutual Fund said, “10 Year Indian G-sec shot by ~20bps to 7.40% in an immediate response to the policy announcement. Currently, in India we are just where Fed was few months ago and yields may face an upward pressure across the tenor of the curve- though liquidity reduction adds an additional element of adjustment at the shorter end."
