Considering the evolving macro-economic outlook, RBI has been pre-emptive in its monetary policy actions and stance in 2019. Since February 2019, it has reduced the policy repo rate by a cumulative 75 basis points (till June 2019). In addition, it has changed the stance of policy from neutral to accommodative, which effectively takes rate hikes off the table, while committing to either rate reductions or maintaining status quo. On August 8, 2019 the Monetary Policy Committee (MPC) in its third bi-monthly monetary policy for fiscal year 2019-20, decided to further cut repo rate by 35 bps from 5.75 per cent to 5.40 per cent while maintaining the accommodative policy stance on the back of subdued inflation numbers and concerns over growth. The reason for an unconventional rate cut of 35 bps given by MPC, was a repo rate cut of 25 bps might prove to be inadequate in view of the evolving global and domestic macroeconomic developments and a 50 bps might be excessive, especially after taking into account the actions already undertaken.
While most of the market participants were expecting a 25 bps rate cut by RBI, the decision to cut rate by 35 bps did not surprise the markets. In fact, the reaction from the markets was quite muted as markets were heavily positioned pre-policy and the participants ended up trimming off positions across the board. So to some extent, the typical reaction one would have expected in 10-year yield did not materialize.
The MPC’s decision to cut rate, was on back of benign inflation projection over the next 12 months, slowdown in both domestic and global economic activity, elevated trade tensions and continued geo-political uncertainty. The benign inflation outlook provided the MPC the headroom to close the negative output gap as domestic private consumption, the mainstay of aggregate demand, and investment activity continued to remain sluggish.
The focus on ‘growth’ can be clearly seen, as the monetary policy resolution stated “addressing growth concerns by boosting aggregate demand, especially private investment, assumed the highest priority at this juncture while remaining consistent with the inflation mandate.”
Going ahead the 10-year benchmark is expected to trade in the range of 6.25-6.40% with downward bias before the next policy. RBI is likely to ensure transmission of 110bps rate easing done so far via adequate liquidity. We expect there is further room for easing as growth is expected to remain muted, the repo is likely to settle down around 5% during this financial year.
The following factors are likely to be closely monitored in the near term, as they could influence further rate action from RBI:
- On global front: US Federal Reserve commentary of rate cuts, rate cuts initiated by other central banks, geo-political situation, trade war dynamics, currency movement, volatility in crude oil prices, etc.
- On domestic front: Progression of monsoon, transmission of earlier rate cuts and growth-inflation dynamics.
With this backdrop, investors can build a fixed income portfolio by investing in income accrual funds with short term duration and take active duration calls using long term bond funds and gilt funds.
We think investors should continue their focus on dynamically managed Short Term Funds – UTI Corporate Bond Fund and UTI Floater Fund, which alter their duration actively and also do not shy away from taking a moderate risk by allocating a small portion of their portfolio to UT Credit Risk Funds, (which has a minimal exposure to low rated and unrated papers) as spreads between corporate bonds and sovereign bonds remain at elevated levels, and provide a good opportunity over a three year plus investment horizon.