RBI MPC Meet: Amber signal tells debt fund investors to keep steady on the path; not too fast, not too slow

RBI MPC MEET

The Reserve Bank of India’s Monetary Policy Committee decided to keep the policy rates unchanged. However, inflation remains sticky at current levels and may take time to come down. That leaves fixed-income investors in a tough situation. Here is how experts advise investors to go about investing in debt funds.

Why the status quo?

Many experts had anticipated that the MPC meet will not tinker with the policy rates.

RBI governor Shaktikanta Das made it clear that the focus on inflation targeting continues as the CPI inflation is projected at 5.1 percent for FY2023-24. This is above the target of 4 percent (within a band of +/- 2 percent) set by the RBI. The central bank has also reiterated that economic growth is on track. It forecast the real GDP growth for 2022-23 at 7.2 per cent and for 2023-2024 at 6.5 percent. The RBI has to target inflation at a time of strong domestic growth and weak global cues in the form of recessionary fears. The situation becomes further complicated due to early indications of El Nino – a weather condition wherein the distribution of monsoon may get adversely affected.

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“The forecast of a normal south-west monsoon by the India Meteorological Department (IMD) augurs well for kharif crops; however, the spatial and temporal distribution of the monsoon would need to be closely monitored to assess the prospects for agricultural production,” says the monetary policy statement.

Though most industry experts agree on the economic growth projections of the RBI, they stand divided on the inflation projections. “Growth remains resilient and the inflation, while moderating now, could rise in the future as the labour market remains tight and wage-inflation spiral remains a distinct danger. Australia and Canada have raised rates after a pause. We are not out of the woods yet,” says Sandeep Bagla, CEO, Trust Mutual Fund.

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Inflation numbers need to be seen in the context of the progress of monsoon as well as global commodity prices. Crude oil is one of the key monitorable. On one hand, expectations of recession are pulling down crude oil prices while on the other hand, the voluntary production cuts by producers can push them up.

Ritika Chhabra- Quant Macro Strategist – Prabhudas Lilladher PMS, says, “The RBI kept its stance unchanged to 'withdrawal of accommodation' as it maintains its focus on inflation, citing delay in monsoon, El Nino impact and geopolitical uncertainties as upside risks to inflation.” She, however, expects FY2023-24 inflation at 4.9 percent slightly lower than the RBI's estimate of 5.1 percent, as the base effect turns favourable and imported inflation eases.

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Policy actions by other central banks, especially the US Federal Reserve, will also weigh on the actions of the RBI.

Impact on fixed-income investments

Bond yields remain in a narrow range with an upward bias after the decision to keep where they are. The 10-year benchmark bond yield quoted at 7.02 percent compared to 6.98 percent on Wednesday. This indicates that the outcome of the MPC meet is in line with the market expectations. The debt funds may not see a big impact of today’s rate action.

In the last three months ended June 7, 2023, as per Value Research, long-duration funds on average have gained 4.72 percent returns as long-term bonds rallied. Liquid funds have given 6.15 percent returns in the last one year as portfolio yields went up.

What should you do?

The rates of interest offered on fixed deposits are attractive. The yield-to-maturity ratios of most debt fund categories have also climbed up. This should offer a good opportunity for investors looking to lock in interest rates. Vijai Mantri, co-founder and chief investment strategist, JRL Money, advises investors against chasing high interest rates as it may lead to high credit risk. “Investors with an objective to preserve capital should look at investing in small savings schemes. With a view to earn tax-efficient returns investors can look at arbitrage funds with a one-year timeframe,” he adds.

A good way to make money from debt funds is to map your holding period with the duration of the debt funds. For example, for someone looking for parking money for a couple of months, liquid funds make sense, whereas, for someone looking to invest for three years, a short-duration fund is a better fit. Do not invest in long-duration funds with the intent to make some quick buck in the short term. If the yields go up, then you will see muted returns.

"The status quo policy and the expectations of a long pause favour a fall in the bond yields if money market conditions are normal. The most suitable positioning for the debt portfolios is to be in the two-to-three year maturity profile, through products like corporate bond funds, and banking & PSU debt funds,” says Joseph Thomas, Head of Research, Emkay Wealth.

Do check the portfolios of debt funds for credit quality, and expense ratio before investing.