Mar 20, 2008

Mutual Fund's view of RBI’s Policy Review

Funds view of RBI's Review

The RBI has maintained status quo in terms of policy direction and highlighted growth moderation in certain industrial sectors, liquidity management and possible upward inflationary risks. This comes amidst increased monetary easing amongst central banks in developed markets to alleviate concerns about economic slowdown and credit market crunch.

In India, liquidity conditions had tightened in recent months due to CRR hikes, MSS auctions and outflows towards equity issuances. This led to the RBI infusing liquidity through repo auctions. The macro environment remains conducive for debt markets, with the central bank achieving its objective of moderating inflation and credit growth, without hampering the economic growth momentum. However, the sharp rate cuts announced overseas and recent comments made by government officials have resulted in increased rate cut expectations amongst a segment of the market. Against this background, the maintenance of policy direction resulted in weakening of investor sentiment and yields moved up across the curve.

The RBI has indicated that its policy making is driven primarily by domestic factors and is not overtly dependent on global developments. It has pointed out that while overall inflationary trends are comfortable, consumer prices need to be considered and global food/oil/commodity prices are a concern. Given the continued strong economic growth, possible demand pressures also appear to have been a key factor in this policy review.

While rate differentials would ideally result in additional capital flows, increasing risk averseness amongst global investors could temper the momentum. We expect the central bank to maintain a neutral policy stance and interest rates to have a downward bias, going ahead. The cautious tone appears to be due to the global uncertainty and possible inflation pressures due to food items and global commodity prices.

But the RBI could announce appropriate measures if growth momentum gets impacted due to international/domestic factors. Investors with appropriate risk profile can look to get invested in long bond funds and short-term income plans continue to be attractive investment avenues, keeping in mind the medium-term rate outlook.

Mr Santosh Kamath, CIO-Fixed Income, Franklin Templeton Investments,  Interest Rate Outlook


The RBI has left key policy rates unchanged in this week's policy meeting (we were never expecting a rate cut in this policy), highlighting upsides in inflationary risk in the period ahead amidst a strong domestic economy. This implies that there has been no change in the RBI's preference for inflation containment over growth. It hasn't said anything that changes the underlying bias of our central bank. The RBI emphasises that growth is 'good' in India though it is faltering in certain OECD countries.

A small indication recognising the impact of high interest rates on consumption economy is in the policy statement. Dis-aggregate analysis of growth shows that consumer expenditure is decelerating and an appropriate policy response may be needed to restore the growth momentum.

The bank notes that a conducive monetary and interest rate environment will be provided to ensure a continuation of growth momentum. We feel that the RBI isn't explicitly recognising that a substantial slowdown is under way in our economy too. As in the US, property prices have come off in India and consumer confidence seems to be eroding, which is reflecting in decline in consumer durables sales over the last one year.

The RBI emphasises its readiness to take timely, prompt and appropriate measures to mitigate the risk to the extent possible in view of global developments. It has left the market in 'uncertain' territory. It is willing to buy time before it indicates a decisive soft stance towards monetary policy setting. Will the RBI cut rates post FOMC meeting? We don't think so. But if base metal prices continue to drop and crude prices ease, we can expect a more dovish stance from the RBI. We reiterate that we are likely to have a softer interest rate regime in our country. Interest rates are likely to get softer over the next few quarters. We expect support for bond prices at 7.60 per cent levels for the 10-year gilt.

We continue to recommend income funds to our investors who are willing to invest for more than six months. Bond yields have moved up by 15 bps across the yield curve and investors should use this opportunity to build duration in their portfolios.

A. Balasubramanian, CIO, Birla Sun Life Asset, Management Company