Posted On Wednesday, Dec 07, 2022
● Policy Repo rate hiked by 35 basis to 6.25% from 5.90%.
● Accordingly, the SDF rate increased to 6.00% and the MSF rate increased to 6.50%
● Policy stance maintained as “withdrawal of accommodation” to ensure inflation remains within the target going forward.
● MPC was divided with 5-1 votes in favor of the rate hike and 4-2 vote for the stance.
● Extended the dispensation of enhanced HTM limit of 23% of NDTL to March 31, 2024. The HTM limits would be restored from 23% to 19.5% in a phased manner starting from the quarter ending June 30, 2024.
Quantum Fixed Income Team’s View
The Repo rate hike of 35 basis points was broadly in line with the market expectation. However, a continuation of the stance as “withdrawal of accommodation” indicates that the rate hiking cycle in India is by no means over. We would expect at least another 25 basis points of a rate hike in February next year before we get any closer to the terminal rate.
The RBI seems to be reasonably comfortable with the growth trend and projects further improvement in the growth outlook. While it highlighted the elevated and sticky core inflation as the main risk to the economic outlook. This suggests that RBI will continue with its hawkish tone until core inflation comes down significantly on a durable basis.
The bond market will be disappointed with the hawkish commentary from the RBI. We might see some selling in the bond market in the coming days. However, given the high level of absolute yields at medium to long-term bonds, we expect the upside to remain capped. We expect the 10-year government bond yield to continue to trade between 7.2% to 7.5%.
Given that credit growth is expected to remain robust while deposit growth is lagging, we do not see any material change in demand for bonds from banks due to the extension of HTM dispensation.
Given the fact that a sizable rate hike has already been delivered and the starting yields on short to medium-duration bonds are between 7.0%-7.5%, bond funds are likely to do better over the coming 2-3 years. Investors with a 2-3 years investment horizon and some appetite for intermittent volatility, can continue to add to dynamic bond funds in a staggered manner.
Rate hikes and continued reduction in durable liquidity surplus are positive for short-term debt fund categories like the liquid fund. We would expect further improvement in the return potential of these categories as interest accrual on short-term debt instruments has risen meaningfully. Investors with shorter holding periods and low-risk appetite should stick to Liquid funds.
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