The Reserve Bank of India surprised markets today by deciding to keep the repo rate and CRR unchanged. This came as a surprise, after the over 11% consumer price inflation in November resulted in economists forecasting rate hikes.
The 10-year gilt yields softened to 8.77% immediately after the policy announcement even as bellwether equity indices, specifically the Bank Nifty, soared.
Wait for data
The Governor stated that the RBI is ‘waiting for data’ and is not being soft on inflation. One such key data to watch for would be vegetables and fruits prices – which were the key drivers of consumer inflation in November.
Interestingly, mandi prices for these food articles remained high in the first 3 weeks of November and came off in the fourth week of November and further fell sharply in the first week of December. The RBI would therefore likely wait for the December inflation numbers to see if this indeed helps tame surging inflation.
That said, one can wonder if the RBI’s move should be seen in the light of increasing pressure on GDP growth; given that we are heading for the last quarter of the financial year. The tightening government spending in the last quarter of the fiscal (to meet budget projections), will acts as headwinds for GDP growth, as acknowledged in the policy statement. This being the case, a rate hike at this juncture could further hurt growth.
Impact on yields
While the ‘no change’ stance provided some relief for long-dated gilts, investors may view this more as a relief rally. Given the rate uncertainty, there could be little trigger for gilt yields to come off sharply.
More importantly, there would be supply of papers coming up over the next 5 weeks; that will likely prevent any big price rally on long-dated gilts. Besides, any open market operation (OMOs) at this stage appears unlikely, given the very comfortable liquidity position in the banking and debt market.
Investors, though, will continue to see softening of yields of short-term instruments up to 1-year treasury bills, thus triggering a price rally.
For mutual fund investors, ultra short-term and short-term debt funds therefore continue to be a more predictable option for appreciation at this point.
Long-term debt funds, especially gilt funds, which took a 0.3% dip over the last week, may recoup their losses in today’s relief rally but may find few triggers to fall for a more meaningful rally. A hold strategy on long-term debt funds is warranted until any further rate move by the RBI becomes apparent.
The risk to the market at this point would come from any decision on tapering by the Federal Reserve, in its two-day meet that is set to begin.
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