RBI may hold off aggressive rate hikes: Axis MF

Investors with a short to medium term view should look to invest in short duration funds as yields in this segment are poised to drop in the near future

October 30, 2013 10:54 IST | India Infoline News Service
The RBI (Reserve Bank of India) in its Second-Quarter Review of Monetary Policy 2013-14 on Tuesday hiked the repo rate by 25 bps (basis points) to 7.75%. The central bank kept the CRR (cash reserve ratio) unchanged at 4%. 

The repo rate is the rate at which banks borrow from RBI and one basis point is equivalent to 0.01%. 

RBI Governor Raghuram Rajan, in his second policy review, has cut MSF (marginal standing facility) rate to 25 bps to 8.75%.
MSF rate is an overnight borrowing rate for banks, which eases the cost of funds for lenders, fuelling credit growth.

The central bank expects GDP at 5% in FY13-14 and CPI to remain at or above 9%.
Commenting on RBI policy, Axis Mutual Fund, said, Two trends have driven the RBI policy recently. First the need to exit the emergency liquidity tightening measures implemented since mid-July; and second a shift from WPI to CPI as the inflation benchmark.

The RBI has been concerned that despite a sharp fall in WPI inflation (and more specifically core WPI, i.e. non-food manufactured products), retail prices continued to rise sharply. The key driver for lower food inflation would be the arrival of the new kharif crop, which is expected to temper food inflation. Minimum support prices have risen at a slower pace this year (about 4% average compared to 23% average last year) & a bumper crop could
lead to control on runaway open market prices (for example in the case of vegetables).

However the new crop will come to market over the coming months and would likely be reflected in price indices starting January. Thus RBI may hold off aggressive rate hikes until we get more data.

Bond Market Outlook & Strategy
Since the last policy announcement, long term yields have risen sharply. Compared to a level of about 8.2% in the morning of September 20, 10-year government bond yield was around 8.65% at close yesterday. In response to the policy, yields have dropped to about 8.59%, about 6 bps lower. At this level, the benchmark 10-year government bond yield is about 85 bps over the LAF repo rate – close to its long term average. For the long bond yield to drop, we need to see a change in the RBI’s stance with respect to the repo rate.
We believe that this will follow a moderation in growth and inflation in the months ahead. Lower price increases in food along with a good harvest will go a long way towards alleviating inflation concerns over time.

Investors with a short to medium term view should look to invest in short duration funds as yields in this segment are poised to drop in the near future. Longer duration funds would outperform once inflation begins to slow allowing the RBI to cut the repo rate.

Sources of data: Bloomberg, RBI

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