The market has been gearing for a rate cut of at least 25 bps since the Union Budget 2016. The fiscal deficit target and the inflation gave the much needed impetus to the markets. As expected by market participants, the RBI governor slashed repo rate by 25 bps.
But many naïve investors tend to forget to look or listen to the commentary and further directions given the RBI governor. So here are the key highlights of the April 2016 monetary policy and what it actually means!
Key points:
- Repo rate slashed by 25bps, bringing it down to 5-year low.
- No changes in CRR. SLR of scheduled banks reduced by 25 bps from 21.5% to 21.25%
Repo rate is the rate at which the central banks lend to commercial banks, while SLR and CRR are percentage of assets (in cash or liquid asset) banks have to hold with RBI. This will help create liquidity with the banks and encourage banks to pass on the benefits of lower rate cut to its borrowers.
- Inflation to decelerate modestly and remain around 5% through March 2017. Inflation risks include monsoon, oil price, civil servant pay hike; downside pressures include tepid global demand, effective food management, fiscal consolidation.
- Gross-value added growth projection for year through March 2017 retained at 7.6%
RBI governor expects the uneven recovery growth in 2015-16 to strengthen gradually in 2016-17, assuming a normal monsoon, demand boost from 7th commission One Rank One Pension (OROP).
- Policy rate corridor narrowed from 100 bps to 50 bps; marginal standing facility rate reduced by 75 bps to 7% while reverse repo rate increased by 25 bps to 6%.
Marginal standing facility is a window for banks to borrow from the Reserve Bank of India in an emergency situation when inter-bank liquidity dries up completely and reverse repo rate is the rate at which RBI borrows money from commercial banks.
- Minimum daily maintenance of the cash reserve ratio reduced to 90% of requirement from 95%
- RBI intends to lower average ex ante liquidity deficit to a position closer to neutrality
It means that RBI has cut rates by 150 bps since 2015 and coupled with ease of liquidity bankers will now have no choice but provide the transmission benefit to their consumers.
What impact does the rate cut have on debt funds?
The rate cut is meant to benefit both medium and short term funds. Investors can expect MTM gains from duration funds. This is because fall in yield provides capital appreciation due to the inverse relation between the bond price and interest rates. It will also narrow the spread between the g-sec and corporate bonds making accrual funds attractive.
Lakshmi Iyer, Chief Investment Officer (Debt) & Head Products, Kotak Mutual fund says, “Accural funds can be considered due to decrease in spread gap of g-sec and corporate bonds which can benefit the investors. The short term yield could dry up due to liquidity measures.”
Her view is echoed by Murthy Nagarajan, Head - Fixed Income, Quantum AMC, “The assurance on liquidity should result in term spreads compressing. Currently, the 10 year G-Sec @ 7.4% is at 90 bps spread over the repo rate of 6.5%. If RBI continues its OMO and pro-active liquidity management; this spread may fall.”
Vidya Bala, Head of MF Research, FundsIndia suggests that gilt and dynamic bond funds cant benefit in short term form such a yield fall as they have already appreciated as much as 3-4% since the beginning of 2016. “Gains would be spread out this financial year, as inflation, pay commission would provide more data points for RBI’s next move. Hence investors looking for long-term exposure can consider a combination of dynamic and income accrual funds,” says Vidya.
