Posted On Friday, Oct 05, 2018
In a surprise move, RBI left the Repo Rate unchanged at 6.5% as against the expectations of increasing it by 25 (0.25%) to 50 (0.5%) bps. We were expecting the RBI to hike the Repo Rate by 25 bps and keep its monetary policy stance as neutral.
The RBI has instead held the rates steady but changed the stance to ‘calibrated tightening’.
With his move, the RBI is likely sending a message to the markets that they won’t use interest rates to defend the depreciating currency and thus have not hiked the interest rates. At the same time to maintain its inflation fighting credibility they have tightened the stance to indicate that if Oil prices increases they will hike the Repo Rate in the coming months. This stance also clearly indicates that the RBI will not be cutting interest rates anytime soon.
In July 2013, post the global episode of ‘taper tantrum’, the RBI had hiked interest rates by 300 bps (3%) to curb speculation on the Indian Rupee, which further depressed sentiment and led to an even sharper sell off in bonds, equities and currencies. With the Indian Rupee, depreciating now , market participants and analysts have been expecting a similar reaction by the RBI in hiking interest rates.
With the RBI now pausing, at a time when the Indian rupee has sold off sharply and markets expectations were riding high on a 50 bps rate hike, the RBI seems to be signaling that they don’t yet see the reason to panic on the external front. The Rupee is depreciating largely due to a rise in oil prices and the RBI has quite a few other means to manage the Rupee. They can sell dollars from their Forex Reserves, open a special window for Oil companies to borrow dollars directly from the RBI, offer higher interest rates on NRI Deposits to get inflows from NRIs...
The other reason for them to not hike interest rates could have also been due to the turmoil in the equity and credit markets. The issue with the default by IL&FS and the steep fall in stock prices of some banks and NBFCs has impacted sentiment in the broader market. The RBI, by hiking interest rates could have further hampered sentiment. As it is, Indian bond yields are already high enough with the 10 year government bond yield at above 8.0% and 3 year AAA PSU bonds near 9.0%. A 50 bps rate hike at this juncture may have led to a further increase in market interest rates.
The RBI having already raised the interest rate by 50 bps in the last 4 months also had the comfort from the slowing inflation. CPI inflation, especially food inflation, continues to shoot below RBIs projections and the previous two pre-emptive hikes does ensure that the RBI Repo rate is ahead of the current inflation trend.
However, given the trajectory of oil prices, if it stays at the current levels or moves up further, we would see the RBI hiking rates in the forthcoming policies. We thus expect the Repo rate to move up to 7.0% from the current level of 6.5% by March 2019.
If the INR continues to depreciate on falling equity markets and higher oil prices, we expect market interest rates to move higher from the current levels.
Also, risks in the system would rise and investment sentiment will fall.
In such a scenario, we would advise investors to remain invested in debt funds which prioritize safety and high liquidity and manage money with prudence by being true to the investment objective of the fund.
Quantum Liquid Fund, prioritizes safety and liquidity over returns and is invested only in less than 91 day maturity instruments issued by Government Securities, Treasury Bill and AAA Rated PSU bonds.
Quantum Dynamic Bond Fund, takes higher interest risks, but does not take any credit risks and is invested only in Government Securities, Treasury Bill and AAA Rated PSU bonds.
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|Quantum Dynamic Bond Fund
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