Rates don’t change, RBI policy stance does

This quarter’s credit policy review has come close on the heels of Union Budget 2017. Both equity and bond markets had reacted positively to the Budget thanks to the lack of negative news on the whole. After that the focus shifted to the monetary policy, with many analysts and market participants expecting the last 25 basis point (bps) rate cut for this financial year. The finance minister had stuck to the fiscal consolidation path with a deficit target of 3.2% for 2017-18. Low fiscal deficit gives some room for a rate cut. One basis point is one-hundredth of a percentage point.

The other side of the argument focused on both domestic and global policy uncertainties and the need to have room to manoeuvre rather than rushing into a rate cut. The latter has prevailed as the Reserve Bank of India (RBI) not only chose to keep rates unchanged but also shifted the policy stance from accommodative to neutral. An accommodative stance suggests that there is room for further cuts in interest rates, while neutral means that the current level of repo rate would prevail for some time.

Equity markets ended the day more or less flat. Focus will once again shift to earnings and fundamentals. It was the bond yields that reacted sharply to the policy announcement. Bond markets had already priced in at least one more rate cut in this financial year and a neutral stance might mean that that will not happen.

Suyash Choudhary, head, fixed income, IDFC Asset Management Co. Ltd, said, “The policy stance is broadly in line with our assessment, however it wasn’t expected that RBI would expressly state the shift. Given the global uncertainties, it’s understood that the benefit of incremental cuts is low and the focus needs to be on macro stability.” The fund’s strategy is to focus on rates in the 3-4 year maturity segment, which seems well anchored at the moment, he added

The 10-year G-sec yield shot up 24 bps to hit a 13 month high of 6.68%. Duration-oriented funds like income funds, gilt funds and dynamic bond funds gave returns moving into double digits in the last year. However, even before the policy move, most fund managers had started to reduce the duration exposure in funds as bulk of the duration opportunity had already taken place. The market reaction was a reversal of what was already priced in.

Sudhir Agrawal, fund manager and executive vice-president, UTI Asset Management Co. Ltd, said, “We expected the RBI to pause but maintain an accommodative stance, but the RBI sounded much more hawkish. This came as a shock to the market but it is a prudent decision for the RBI to make. For investors where duration is part of asset allocation, they can continue. For those looking at duration as a thematic trade, it is probably time to move a step lower to short-term funds.”

Fixed income investors need to note that the RBI governor suggests linking small savings scheme returns to the 10-year G-sec yield. The current yield at 6.60-6.70% is much lower than the 7.5-8% that some of these securities give.

RBI governor Urjit Patel said in the press conference: “There is still scope for the lending rates to come down because our policy rate came down by 175 bps and the weighted average lending rates have come down by about 85-90 bps. I think there is scope for some more transmission. Some sound borrowers, in housing finance, have already got the benefits.” However, the policy documents on RBI’s website said that the environment for timely transmission of policy rates to banks’ lending rates will be considerably improved if: the banking sector’s non-performing assets (NPAs) are resolved more quickly and efficiently; recapitalization of the banking sector is hastened; and the formula for adjustments in the interest rates on small savings schemes is linked to changes in yields on government securities of corresponding maturity is fully implemented.

Meanwhile, in Budget 2017-18, finance minister Arun Jaitley had said that there is early evidence of an increased capacity of banks to lend at reduced interest rates. As of now, the cheapest home loan you can get is from Bank of Baroda at 8.35%. Though both the government and the apex bank are nudging the banking industry to reduce interest rates further, it is unlikely that your home loan rates will reduce steeply. “Large lending rate cuts have already happened with SBI (State Bank of India) reducing MCLR (marginal cost-based lending rate) to 8%. You won’t see such a steep rate cut,” said Alpesh Mehta, analyst, Motilal Oswal. If you plan to take a housing loan, opt for a floating rate. The fixed deposit rates are also likely to remain the same for large commercial banks, but there is a new set of banks in the market. Hence, you will continue to see competitive pricing in fixed deposits at least for the next 1-2 years, as the newly launched small finance banks look at reducing their cost of funds.

RBI also stressed on cyber security. “It has been decided to constitute a standing committee on cyber security. It will be cross-functional and will have industry experts as well as government representative,” said S.S. Mundra, deputy governor, RBI.