More rate cuts likely debt funds still well-poised

More rate cuts likely debt funds still well-poised

 

The bi-monthly credit policy signals stance is shifting from containing inflation to reviving growth and so further rate cuts cannot be ruled out.

 

IF THERE WAS A DOUBT THAT Reserve Bank of India (RBI) would hold rates firm, it was laid to rest in the second bi-monthly monetary policy. After all, consumer inflation has been benign for some time now and credit growth has also been a tad sluggish, so a 25 basis point cut was in the offing and given the wide consensus this time, the RBI didn’t disappoint.

What is important to note is that despite the fact that RBI has been cautious on inflation, especially food inflation, the slower credit growth, patchy economic recovery, under investments and lower capacity utilization have been a driving factor for the cut in rates, as cited by the RBI. This perhaps shows that the RBI’s focus is now shifting from containing inflation to reviving growth, and is a welcome sign for the broader economy.

The RBI has cautioned about the coming monsoons saying that a below average rainfall may result in lower food output and therefore raises the chances of a spike in food inflation.

However, for now, CPI inflation looks fairly contained and range abound between 5.25-5.50 percent, and is likely to be within RBI’s comfort zone of 6 percent by January 2016. Continuing on the inflation front, oil prices are likely to remain low adding to the optimism. What’s more, the government is expected to initiate policy actions that could be successful in reigning food inflation if the monsoons are not near average levels.

So given the sluggish economy, we still think there’s enough scope for further rate cuts. First, we think given that investment and credit growth could remain low for the next 4-6 quarters, the country’s Central Bank could reduce rates further by 25-50 basis points in this financial year. So the broad signs of the interest rate trajectory continuing downward remains.

The RBI might pause before further rate cuts to see the progress of the monsoons and see how inflation behaves, but if the investment and credit growth remains a low, further rate cuts cannot be ruled out.

One trend worrying the markets has been the global currency movements. However, we think that the rupee is among the well-behaved currencies in the world and has held up even in the recent times when emerging market currencies were taking a beating. So concerns on that front might not necessarily pan out on expected lines.

For investors, there are opportunities in the debt space with the 10-year bond hovering at yields of around 7.75%. It shows that there’s scope for the RBI to reduce rates further over the course of the year.

Hence, longer-duration bonds funds are still the place to remain invested given the downward trajectory of the rate cycle. For those investors looking at the conservative side, one could consider adding a dash of short- and medium-term bond funds as tapering of rates is likely to add enough buoyancy to these funds.

Happy Investing