RBI holds repo rate again. Here’s what fixed-income investors should do

RBI policy action: How should debt fund investors position themselves now?

The Reserve Bank of India (RBI) on December 6 held the repo rate steady at 6.5 percent for the 11th time but raised hopes of a rate cut in February.

The RBI's monetary policy committee (MPC) also raised its inflation forecast for FY25 to 4.8 percent from 4.5 percent and lowered the economic growth numbers. It now expects GDP growth for the year ending March 2025 to 6.6 percent from its earlier forecast of 7.2 percent following the weaker-than-expected print for the second quarter.

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Rate cut expectations

Leaning on prudence, the MPC, by a 4:2 decision,  policy rate unchanged at 6.5 percent amid higher food inflation but cut cash reserve ratio (CRR) to 4 percent from 4.5 percent to ease liquidity in the banking system.

“This probably means first rate cut will potentially be in February 2025, in our view,” said Dhawal Dalal, President & Chief Investment Officer-Fixed Income, Edelweiss Mutual fund.

Trust Mutual Fund chief executive officer Sandeep Bagla said two of six MPC members voting for a rate cut in December meeting shows that the possibility of a cut in February is very high.

Yield movements

In debt markets, 10-year government bond yield was trading 4 basis points higher at 6.72 percent after the policy announcement.

The MPC kept infused liquidity into the banking system by slashing CRR by 50 basis points. “The banking system will get liquidity of around Rs 1.16 lakh, crore which will bring down the rate s going forward as the banks will be in position to lend more at the cheaper rates. Inflation likely to moderate in the coming months as the kharif crops is on the way and will ease the food inflation,” said Deepak Panjwani, Head, Debt Markets, GEPL Capital.

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The 10-year benchmark yield tested 6.6494 percent and later moved to 6.72 percent. “We maintain our year-end target for 10-year benchmark of 6.55 percent with a possible repo rate cut in February 2025,” said Panjwani.

According to Feroze Azeez, Deputy CEO, Anand Rathi Wealth, the unchanged repo rate makes debt mutual funds, especially those focused on government securities, more attractive.

"Long-duration bonds are expected to benefit and 90 basis points gain in the 10-year G-Sec yields today. This signals an opportunity for investors in long-term debt instruments to potentially realize better returns," Azeez said.

Impact of CRR cut on debt market

According to financial adviser Kirang Gandhi, the 50 bps cut in CRR is a game-changer, injecting Rs 1.16 lakh crore of liquidity into the banking system.

“This move is a boon for debt mutual funds, especially short-duration and liquid funds, as it stabilises yields and bolsters credit conditions. Smart investors should capitalise on this scenario by focusing on quality debt funds and closely monitoring the performance of the banking sector for emerging opportunities,” he said.

Bet on long-duration bonds

Bond yields usually often move in anticipation of interest rate changes. Over the past year, India’s 10-year bond yield has been on a downward trend falling from 7.10 percent levels to around 6.72 percent level this week.

Bond prices and yields have an inverse relationship. When yields fall, the prices typically rise. Since debt mutual funds hold a portfolio of bonds, the net asset value (NAV) of the fund usually increases as bond prices go up.

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According to experts, the overall situation remains bond-positive, with a clear expectation of rate cuts and a favourable demand-supply situation.

Panjwani recommended locking in for the longer end of the curve, as the rate easing cycle has begun and look for some top performing gilt funds. Manish Chowdhury, Head of Research, StoxBox, said while yields have already receded on rate cut expectations, long duration funds are best placed to benefit from this as they would respond faster to any rate cuts. “Investors with a long-term horizon and higher risk appetite are advised to opt for long duration bonds,” Chowdhury said.

According to Vishal Goenka, co-Founder of IndiaBonds.com, fixed income investing prefers a stable, almost "boring" environment and that is exactly what has been delivered. “Investors to continue using fixed income for effective portfolio construction. A barbell strategy with buying short end corporate bonds with long end G-Sec and bank infra bonds is suggested for benefiting from carry as well as potential capital gains," he said.

The Barbell strategy is investing at two ends of the risk spectrum and leaving out the middle–like a physical barbell. In bonds, this could be done by holding riskier long-term ones on one end and short-duration ones on the other.

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Pankaj Pathak, a senior fixed-income fund manager at Quantum Mutual Fund, also said with interest rates expected to go down in future, it would be advisable for investors to allocate more towards long-term fixed deposits or bond funds that invest in long term bonds. “Dynamic bond funds can be a suitable option for investors looking for long term fixed income allocation,” said Pathak.