Debt funds with maturity in the range of, say, 1-3 years are preferable for fixed income investors
The first meeting of the new-look Monetary Policy Committee (MPC), last Friday was on expected lines as there were no expectations of rate cuts in the immediate term. The reason for there being no rate-cut expectations was obvious: inflation has been consistently higher than RBI’s tolerance level of 6 per cent. The RBI has already reduced the repo rate by 115 basis points since March this year, and the effective rate reduction has been even higher.
Given the liquidity infusion carried out by the RBI in the overnight market, the operative rate is now the reverse repo rate of 3.35 per cent rather than the repo rate of 4 per cent.
What then could the RBI do? It has already cut rates, infused liquidity in the banking system and supported the huge government borrowing program by open market operation (OMO) purchase of securities and ‘twist’ OMOs where it purchases longer maturity G-Secs and simultaneously sells shorter maturity instruments.
But, the RBI pulled something out of the hat.
Steps taken by the RBI
- The MPC voted unanimously for the continuation of the accommodative stance. It voted 5-1 to continue having an accommodative stance during FY2021 and into FY2022, thus giving an assurance to the market that it continues with the “whatever it takes” approach to supporting the economy and government borrowing;
- The MPC stated that factors for the current high CPI inflation are supply-related and that they can be overlooked at this juncture. Hence, even if inflation is higher for another month or two, it will not unnerve the market. Expectedly, as and when inflation falls below the outer bound of 6 per cent, the MPC may reduce interest rates further;
- On-tap TLTRO: The governor announced on-tap TLTROs with tenors of up to three years, for amounts up to Rs 1 lakh crore, at the repo rate, till March 2021. These funds can be deployed in corporate bonds, commercial papers, and loans and advances issued by entities in a specific sector;
- SLR (statutory liquidity ratio) holdings in the HTM (held-to-maturity) category: RBI extended the period of increased HTM limits of 22 per cent to March 2022, from March 2021 announced earlier, for securities acquired between September 2020 and March 2021;
- Increase in OMO auction size: The RBI will continue to conduct market operations, outright and special OMOs, with the size increased to Rs 20,000 crore from the earlier Rs 10,000 crore;
- OMO in State Development Loans (SDLs): In a first-time move, the RBI decided to conduct OMOs in SDLs (as a special case) in FY2021. The heavy government borrowing program is not only from the central government, but from States as well.
All these measures mean that RBI is walking the talk on supporting the system, even when its hands are tied with respect to taking the conventional route of further rate cuts.
Implications for debt investments
What is the impact of these measures on fixed-income investments? It is good for your existing investments in bonds or debt funds. Yield levels in the market have reacted positively, with the message of support coming from the big daddy. However, with yield levels being lower than what they were, say, one or two years ago, fresh investments made now will fetch you that much lower. Moreover, the 10-year maturity range is where it is today, within 6 per cent, by virtue of support from the RBI. Otherwise it would have been at a higher level, which also means that, but for RBI’s support, there is upward (i.e. bearish) pressure on 10-year yields. Hence, debt funds with maturity in the range of, say, 1-3 years are preferable for fixed income investors as potential volatility would be relatively lower.(The writer is a corporate trainer (debt markets) and author)