Quantum View: RBI Cuts; Repo Rate Back to 6%

Posted On Thursday, Apr 04, 2019


The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) delivered its first consecutive rate cut since it was formed in October 2016. The MPC had cut the Repo rate by 25 bps (0.25%) in February 2019 and they have now cut the Repo rate by another 25 bps in its April 2019 monetary policy review.

These two 25 bps rate cuts takes the Repo Rate back to 6.0%, a level it had reached in August 2017, which was then followed by two successive rate hikes in June and August 2018 of 25 bps each. The Repo Rate thus has remained in a tight range of 6.0% - 6.5% in the last 2.5 years. But Market interest rates (bond yields), bank fixed deposits and lending rates have moved in a wider band and they are higher than the levels of 2016. This is instructive to know that RBI actions many not have similar impact on the market interest rates.

The RBI and the MPC thus should move focus on the transmission of the lower Repo rate on to getting the banks to reduce the bank lending rates, lower EMIs. Lending rates continues to remain high and the overall economy is not enjoying the benefits of the lower interest rates as seen from the Repo Rate.

There seems to be a need to add (infuse) more liquidity into the system which will allow market interest rates and lending rates to move lower. The RBI has indeed added large amounts of liquidity in the markets in the last year but we believe there needs to be further addition of liquidity to yet fully re-monetize the economy two years post demonetization (which had removed currency from circulation).

The RBI will also have to communicate to the markets in an emphatic manner that interest rates can remain low for a period of time allowing market participants certainty in their actions.

The 25 bps rate cut was as per market expectations, but 2 of the MPC members have again voted for no change. The markets were expecting a consensus (6-0) voting for a rate cut. The RBI has now reduced its inflation forecast by more than 0.5% (50 bps) over the last two policies but despite that the MPC hasn’t had consensus on rate cuts. We find this to be a bit puzzling and wonder if there are certain externalities which have not been factored in their forecast but which is worrying the MPC members. As based on their forecast, the MPC expects CPI inflation to average 3.4% in FY 2020. The Repo rate is at 6%. That gives an Average Real Repo Rate of 2.6% for the next year; well above its ideal level of 1.5%.

The MPC has indeed retained the future monetary policy stance at neutral; they rightfully seem cautious about oil prices; have assumed normal monsoon and are more sanguine about growth prospects than what the current drop in activity suggests. This along with the 4-2 voting thus raises the bar for another rate cut despite the lower inflation projection.

The bond market was priced for a 25 bps cut and for expectations of more to come, which we believe will be scaled back. The MPC meets next in June first week, by then, India would have known who has formed the next government and would have the first confirmation on the onset and likely progress of the monsoon. A non-BJP government and hazy monsoon outlook may keep the MPC on hold in June.

Bond Yields has reacted upwards reversing the gains it had posted over the last week. At 6% Repo Rate, the 10 year government bond yield at 7.25% - 7.35% remains fairly valued. But on the prospect of higher bond supply, lower potential OMO purchases and uncertainty on further rate cuts, the bond yields will continue to remain at a higher level than what is required at the current state of the economy and monetary policy stance. Add to that, the uncertainty on oil prices and on the election outcome, the trajectory of longer tenor bond yields remain uncertain and may remain volatile. This aspect will continue to impede actual transmission of rates onto the economy.

Investors in debt mutual funds should expect slightly lower returns from liquid funds as the rate cut reduces yields/accrual on short term instruments. Fixed Deposit Rates should remain range bound around the current levels; so will lending rates unless RBI takes steps to lower them. Investors in Bond Funds, as always will have to remain aware of the near term volatility in interest rates and invest only with a 2-3 year view.

Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.

Mutual fund investments are subject to market risks read all scheme related documents carefully.

Please visit – www.QuantumMF.com to read scheme specific risk factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the schemes objective will be achieved and the NAV of the scheme(s) may go up and down depending upon the factors and forces affecting securities market. Investment in mutual fund units involves investment risk such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the sponsor / AMC / Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited. The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.

Above article is authored by Quantum.

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