As expected, in its second bi-monthly monetary policy review for 2021-2022, RBI kept the main policy rates unchanged. Cash Reserve Ratio (CRR) remained unchanged at 4%. As a reminder, this rate was brought down from 4.40% in March 2020. Cash Reserve Ratio (CRR) is the share of a bank’s total deposit that is mandated by the Reserve Bank of India (RBI) to be maintained with RBI as reserves in the form of liquid cash. An upward revision in the same would have sucked out money from the banking system. Banks would then have lent at higher rates.
Reverse repo stayed at 3.35% and the marginal standing facility (MSF) at 4.25%. Reverse Repo is the rate at which RBI borrows money from the banks and is linked to the repo rate. MSF is also a means for banks to borrow from the banks.
So what does that mean from an investment point of view ? Before I answer that let us understand that your investments in debt mutual funds and bonds are linked to secondary market yields. Just like you buy and sell equity at stock exchanges, debt too has a secondary market where you buy and sell existing debt instruments which may have been issued by the central government, state government or corporates. Demand and supply of these instruments determines the price of the particular instrument. This in turn impacts the net asset value of your debt fund. This is why , although the policy rates do not change, the NAV of your debts funds or your portfolio holdings change.
Having understood that let us understand where are the secondary markets yields headed ? If they rise, the price of your current holdings will fall.
Interest rates are a tool that central banks use to control inflation. Inflation and interest rates are inversely co-related. If inflation is within the targeted range, there is less pressure on RBI to increase interest rates. Inflation for April 2021 came in at 4.29%. While inflation has come down over the recent months, it is still above RBI’s comfort level of 4%, although within its targeted range of 2%-6%. While rising commodity and oil prices and recent supply side disruption on account of COVID-19 are going to put an upward pressure on inflation, a good monsoon will work positively in keeping this figure low. The projected rate for inflation for FY22 is 5.1%.
Economic growth of a country is measured in growth of gross domestic product (GDP). GDP growth was earlier projected at 10.5% for FY22 and has been brought down to 9.5%, post the second COVID wave. While a recovery in international markets will augur well for exports, there is likely to be an impact on domestic demand on account of unemployment because of the second covid wave. This implies that RBI will continue to support growth for a longer period by trying to keep interest rates low.
RBI has adopted an ‘accommodative stand’. This implies that they would look towards augmenting growth and therefore try and keep interest rates low. Does that mean that the secondary market yields that affect our portfolio will remain benign? RBI, through liquidity management (infusion of money into the market) will try and keep the yields low but what eventually happens to secondary market yields will depend on how inflation and economic growth (among other factors) play out in the next few months and what the market expects going forward.
To summarize, the next few months are going to be volatile. During these times one should invest in the shorter end of the yield curve in products as liquid mutual funds, ultra-short-term funds, low duration funds. Expect low single-digit returns. It is also the time for you to lock into a fixed deposit or a bond which tides over the coming few months. Some banks give as high as 5% in your savings account. One can just stay put in savings accounts also.
Hena Nagpal is managing partner at Altamount Select. These are the author’s personal views.
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