PRESENT RBI POLICY—2023

SARASIJ MAJUMDER

POLICY

MPC holds rates as expected, signals limited room for cuts in H2FY24 MPC’s second bi-monthly Monetary Policy Review: 2023- 24: The MPC unanimously voted to keep the policy rate unchanged. Their stance of focusing on withdrawal of accommodative conditions also retained with emphasis on the 4% inflation target in the medium term and smaller than expected downward revision in CPI inflation. Policy Actions Repo rate maintained at 6.50%. Consequently, SDF at 6.25% and MSF at 6.75%. RBI kept CRR unchanged at 4.50%.

MUTUAL FUND

Impact on the Mutual Fund Industry Liquid Funds: These schemes will continue to generate returns around the operating rate due to their portfolio composition i.e. being invested at the shorter end of the money market segment. Liquid funds have low average maturity as they concentrate more on high quality papers including CPs, CDs and other debt securities with residual maturity of upto 3 months. Ultra Short Term / Low Duration / Money Market Funds (Maturity Up to 1 Year): These schemes predominantly invest in below 1 year maturity paper. The strategy adopted by these schemes is to hold the paper till maturity and capitalize on the running yield. Hence, returns in this category will continue to remain relatively attractive depending on the positioning of the fund. Short Duration Funds: Schemes in this category are predominantly invested in Corporate Bonds, CPs and CDs while a few of them also have some exposure to G-Secs. We continue to remain bullish at the shorter end of the curve. Investors may consider these funds (with an investment horizon commensurate with the maturity profile of such funds) and gain from current accruals and capital appreciation in the event of a fall in yields. Medium Duration: Given the flattened yield curve there are sufficient buffers in the intermediate duration (3-6 years) segment. Till the time RBI is anchoring the long end of the yield curve, the current yield curve may provide some cushion even if there are mark-to-market losses. Investors may consider those funds with high quality portfolios and where the investment horizon is commensurate with the maturity profile of the funds and also gain from current accruals and capital appreciation in the event of a fall in yields. Credit Risk Funds: We remain cautious on Credit Risk Funds as they have failed to prove their mettle in the last 2-3 years with the overhang of defaults and erosions of NAV on the back of mark-to-market impacts due to the aforementioned. The uncertainty around credit funds which are in an open ended avatar continues to pose risks to investors. Much also depends on the liquidity conditions in the market and redemption pressure on these funds. Thus, we think there is a systemic risk in the market within the credit space. Hence, it makes sense for one to stay away from these funds. Impact on the Mutual Fund Industry Long Term Income Funds / Gilt Funds / Dynamic Bond Funds: The RBI, in today’s monetary policy meeting, unanimously held repo rate at 6.50% which was unchanged for the second consecutive time and maintained its stance on focus of withdrawal of accommodation. This pause on rate hikes is aimed at financial stability and future course of action shall be data dependent. Given our light economic calendar, where interest rates have peaked out and are likely to move in a tight range in a near future, global developments could work to drive price action. Domestically, after multiple months of sticky inflation, CPI for the month of Apr ‘23 has finally cooled off to an 18-month low at 4.70% (lowest since October 2021). High GST collections, manufacturing and services PMI are in the expansionary phase, improvement in consumer sentiments and lower unemployment rates indicates strong domestic economy. Trade deficit for Apr’23 narrowed to a 2-year low and was mainly led by a sharp fall in the non-oil imports. Narrowing trade deficit bodes well for a stronger currency. The US Fed in its May FOMC policy meeting confirmed that the central bank is pivoting to a pause as it moves to a data-dependent approach, while the minutes showed that concerns still remain over inflation. The prospect of rate cuts in CY23 was ruled out while the need to keep policy restrictive was emphasized. Global crude oil prices continue to drift lower as physical markets remain over-supplied and global risk aversion has remained in place. In its recent meeting, OPEC+ sticks to 2023 oil production targets as Saudi Arabia announces further voluntary cuts. Interbank call money rates in May remained below the RBI’s repo rate of 6.50% due to comfortable liquidity in the system. The RBI intermittently conducted variable-rate repo auctions during the month to infuse more liquidity. The 10-year yields oscillated in a tight range of 5 bps throughout the month after softening by around 10 bps in the initial few days of the month and closed at 6.99% on May 31, 2023, as opposed to 7.11% on April 28. The bond yields initially reacted on the back of cooling inflation and expectation of U.S. Federal Reserve pivoting. Further, the RBI’s announcement pertaining to the withdrawal of highest value currency (Rs 2,000 denomination) notes is likely to improve banking system liquidity. Impact on the Mutual Fund Industry In the near term, domestic macroeconomic fundamentals are strengthening but the outlook on monsoon and the potential impact of ElNino conditions remain uncertain. Inflation trajectory along with external factors like global growth, inflation and central banks actions may continue to influence the direction of bond yields. Therefore, the MPC shall remain vigilant on the evolving inflation and growth outlook and shall be ready to take any further monetary actions if warranted. On the policy day 10-year yields hardened by 4 bps to close at 7.02%, while from the last policy yields are down by 19 bps. We expect liquidity to remain tight which will be led by the ongoing credit offtake, which is likely to keep interest rates at the shorter end elevated. The longer end of the curve may be anchored or shall react to the appetite of participants to absorb the bond supply and evolving macros and could see some support by the RBI via measures such as OMOs. Conservative Hybrid Funds-CHF (Erstwhile: Monthly Income Plans (MIPs): With between 10% to 25% allocation to equity, returns of CHFs are largely determined by the vagaries of the equity markets as against the debt markets. These funds are therefore suitable for investors who have a reasonably long time horizon & are comfortable with taking exposure to equities. Outlook Early disinflation and high real interest rates amid normalizing growth indicate the current tightening cycle is close to the end gap.