BackOpinion | RBI says 'Main Hoon Na' to bond market
Over the course of the year, the RBI will have to bite the bullet and communicate the change of stance from accommodative, as real interest rates, net of inflation, are negative
PremiumLet us start with a perspective on the role of or expectations from the RBI at the current juncture. We are moving ahead from times of unprecedented slowdown (negative 23.9% in April-June 2020 and negative 7.5% in July-Sep 2020) to high growth, albeit helped by lower base i.e. slowdown in 2020-21. With growth normalizing, money supply in the economy being on the higher side and commodity prices nudging up and pushing inflation, it is a matter of time the RBI moves from extraordinary low interest rates towards normalization. At the same time, there is a huge fiscal deficit of the Government and big-time borrowing from the market. The implication is, the borrowings through Government bonds may disrupt the bond market by pushing yield levels (interest rates) higher. The Government Securities yield curve is the reference point for pricing of the whole gamut of bonds i.e. Government, corporates, etc. and resource raising. Yields moving up immediately would not be a welcome development as that would push up interest rates at a juncture when the Government is spending so much to pump up the economy. So what does the RBI do? Do a balancing act on a tightrope, on one hand give the message that interest rates have to eventually move up, as we normalize, at the same time keep Government bond yield levels steady.
The governor, in his speech and subsequent press conference, reiterated the accommodative policy stance - read maintenance of low interest rates e.g. repo rate at 4% / reverse repo at 3.35%. The text is “unanimously decided to continue with the accommodative stance of monetary policy as long as necessary – at least through the current financial year and into the next year – to revive growth on a durable basis";
Net-net, what has the RBI done? They have dropped hints at reversal by saying GDP growth is going to pick up, projected at 10.5% in 2021-22, though slightly lower than the Government estimate in the Union Budget. They said inflation in the first half of the coming financial year is expected to be higher than what was projected in the December review. Still, they maintained the accommodative stance which means rates will remain on the lower side and banking system liquidity will remain much in surplus.
They have announced certain other measures e.g. a special funding scheme which is available from RBI to Banks at cheap rates for giving loans to certain eligible sectors, has now been extended to NBFCs as well. Now, banks can avail of these funds, lend to NBFCs, who can onward lend to companies in the eligible sectors. This will enhance the reach of this funding measure, as NBFCs provide the last mile connectivity to certain entities. Moreover, lending to MSMEs up to ₹25 lakhs have been given an exemption for maintenance of cash balances with the RBI. This means the RBI is incentivising bank lending to MSMEs, a corollary to the Government spending delineated in the Union Budget to pump up the economy.
Conclusion
Over the course of the year, the RBI will have to bite the bullet and communicate the change of stance from accommodative, as real interest rates, net of inflation, are negative. Subsequent to change of stance, some time in future, we will witness reversal of interest rates. For the time being at least, they are supporting GDP growth and the huge Government borrowing from the market. May be six to nine months down the line, we will witness the change in stance and thereafter the normalization of rates. Investors in debt mutual funds are advised to remain in shorter maturity funds, say portfolio maturity up to 3 years, as longer maturity funds will be impacted more when interest rates reverse. As and when interest rates move up, bond prices come down, thereby impacting funds holding those bonds. Longer the portfolio maturity of the fund, the higher is the impact. Roll-down maturity funds, where the AMC states that the portfolio maturity will gradually come down with passage of time, are also a good idea as the impact will be relatively lower. In these funds, over your investment horizon, if interest rates were to move up, the portfolio maturity and consequent impact will be that much lower.
(Joydeep Sen is a corporate trainer (debt markets) and author. Views are personal and don't reflect Mint's.)
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