Post RBI Policy comment by Pankaj Pathak, Quantum AMC

 

Comment :

The 50 basis points rate hike was more or less as per the market’s estimate. But there was an expectation that the rate hiking cycle is coming close to its end.

The RBI was fairly hawkish in its policy statement. At 5.4%, the repo rate is already above its pre-pandemic level. Yet, the RBI has maintained its policy stance as ‘withdrawal of accommodation’. This suggests that the neutral level of the repo rate is at or above 6% from where the last rate cutting cycle had started. So, the rate hiking cycle is not over yet.

The RBI also seemed concerned about the external sector and its impact on the Indian Rupee. The worry on external sector is three folds – the current account deficit is uncomfortably high, capital inflows have fallen and the foreign exchange reserves are dwindling fast. Rate hikes and quantitative tightening in the US and other advanced economies remain a big risk for capital flows in the emerging markets. Thus, the RBI’s concerns are justified and it would keep the risk of repo rate going significantly above 6% alive.

The bond market sold off after the policy announcement with yields moving higher by 15-20 basis points across the curve. Given the bond yields have come down significantly over the last month, there is a possibility of a further rise in the bond yields in short term. However, from a medium-term perspective, another 50-60 basis points of the rate hike is already in line with the market’s thinking. Thus, bond yields may not move up significantly from current levels. We expect the 10-year G-sec yield to find support around 7.5%.

Medium to long-term investors with 2-3 years holding period, should consider adding their allocation to dynamic bond funds to benefit from higher yields on medium to long-term bonds. Dynamic bond funds have the flexibility to change the portfolio positioning as per the evolving market conditions. This makes dynamic bond funds better suited for long term investors in this volatile macro environment.  

Investors with a shorter investment horizon and low-risk appetite should stick to liquid funds. With an increase in short-term interest rates, we should expect further improvement in potential returns from investments in liquid and debt funds going forward.

Since the interest rate on bank saving accounts are not likely to increase quickly while the returns from a liquid fund are already seeing an increase, investing in liquid funds looks more attractive for your surplus funds. Investors with a short-term investment horizon and with little desire to take risks should invest in liquid funds which own government securities and do not invest in private sector companies which carry lower liquidity and higher risk of capital loss in case of default.