MC Interview| RBI Policy: Expect status quo on rates, says Puneet Pal of PGIM Mutual Fund

Puneet Pal, Head-Fixed Income, PGIM India Mutual Fund

The Reserve Bank of India (RBI) is likely to maintain status quo in the upcoming monetary policy in August despite the marginal surge in inflation in June, said Puneet Pal, Head - Fixed Income, of PGIM India Mutual Fund, in an exclusive interview with Moneycontrol on July 21. The MPC is scheduled to meet on August 8-10 to review interest rates.

In the last two monetary policies, the RBI has kept rates unchanged after increasing 250 basis points since May last year.

Pal said the rising inflation will not force the monetary policy committee’s stance to change the status quo on policy rates as inflation is still expected to remain below the upper threshold of 6 percent.

In June, India's headline retail inflation rate rose to 4.81 percent from 4.31 percent in May, pushed up by a rise in vegetable prices and fading away of the favourable base effect, after falling for four consecutive months.

Higher food prices drove inflation higher in June, with the Consumer Food Price index of the CPI rising 2.5 percent month-on-month.

Bond market yields have been stable in India in contrast to the volatility seen in global bonds. Our stable macroeconomic backdrop is contributing to stable yields.  We think that over the next couple of months, the benchmark 10-year bond yield should trade in a broad range of 7.00 percent to 7.25 percent.

Also read: Govt borrowing cost may stay elevated as path to 4% inflation uncertain: Govt source

Yes, we can expect a new benchmark 10-year bond to be issued in August going by the recent history where the central bank has issued a new security after the outstanding amount reaches Rs 1.50 lakh crore.

I will put this in a different way. The central bank is not continuously trying to withdraw liquidity from the markets. It is just absorbing excess liquidity and injecting liquidity through variable rate reverse repos and variable rate repos respectively, so that the overnight rates stay close to the policy repo rate.  When the RBI hiked CRR last year, that action can be termed as an active measure to withdraw liquidity and the current intervention of RBI through reverse repos and repos is only to smoothen out the volatility in the overnight rates.

It is difficult to guess the ideal level of surplus liquidity which is required in the banking system to keep overnight rates close to the repo rate as it depends on the distribution of liquidity as well. We think that a surplus liquidity in the banking system in the vicinity of Rs 70,000 crore - Rs 90,000 crore may keep the overnight rate close to the policy repo rate.

We expect status quo on policy rates in the forthcoming MPC meeting in August. Vegetable prices have increased in the last one month and food prices in general may rise due to skewed spatial distribution of monsoons and global geopolitical events. But we think that this will not force MPC’s stance to change the status quo on policy rates as inflation is still expected to remain below the upper threshold of the MPC’s inflation target of 6 percent. Commodity prices, especially crude prices still remain benign and inflation has started to trend lower in developed markets too. As such, we believe that MPC will maintain the status quo on rates.

Also read: Retail inflation snaps falling streak, rises to 4.81% in June

Investors looking for short term deployment or investments can consider Ultra Short Duration and Money Market Funds as these funds have low duration risk. Investors who are looking to invest for the 2-3 years horizon can look at Corporate Bond Funds as they generally have a duration of up to 3 years. Investors having an investment horizon greater than 3 years can look at Dynamic Bond Funds as they actively manage duration to take advantage of changes in interest rates.

While investing, investors should keep in mind the risk and consider the Potential Risk Class (PRC) bucket of the fund before investing. The PRC matrix reflects the maximum risk a fund can take both in terms of credit and duration.