RBI puts the ball in Govt’s court

The bond market may be ripe for a rally over an 18-month plus time frame if the inflation does not stray away from the RBI’s comfort zone

June 03, 2014 4:11 IST | India Infoline News Service
Instead of calling the tone of the Bi-monthly Monetary policy statement hawkish or dovish, we would like to believe that it indicates continuity in the RBIs view on both inflation as well as growth.

What however, appears a bit out of syllabus could be the RBIs confidence in the rupee, reflected in allowing higher remittance as well as allowing additional exposure in the domestic currency derivative market by foreign investors. Besides, the cut in the SLR by 50 basis points suggests that the RBI is signalling banks to stay ready to lend, in the event of a revival in the economy and a consequent increase in credit demand. 
Initial cues of end of rate hikes
The no rate change note, although expected, appears to provide initial cues that the rate hike regime may be a thing of the past, unless inflation moves completely out of the trajectory that the RBI has set for it until 2016 (6% by January 2016).

That said, while the RBIs statement on faster disinflation providing headroom for rate cut seemingly suggests a positive stance, it may not entirely be the case. For one, the RBI has explicitly stated disinflation adjusted for base effects meaning that any lower inflation merely on account of the high base effect (expected between June and November) cannot alone trigger a rate cut.

Two, the rate cuts would also hinge on other policy moves such as fiscal consolidation (will be known during budget) and other factors such as minimum support prices or rural wages, all of which play a key role in the inflation chart. Hence, the impact of policies and reforms of the new government will play a key role in the rate change decision.
Ripe ground
Be that as it may on the policy side, the debt market has shown some steady traits since September post Dr. Raghuram Rajans takeover as Governor of RBI. One, the 10-year gilts have been mostly range bound and less volatile mostly in the 8.5-8.75% levels in recent months.

Two, such stability has led to a massive increase in positions of FIIs in the debt market 2014. In fact, the RBIs move to cut SLR, in a way, suggests that the government has sufficient capital flows coming from other-than-bank sources for its bonds.

FII net investment in the debt market has close to doubled between January and May of 2014, when compared with similar 5 months of 2013, suggesting build-up of positions, on rally expectations.
What it means for retail MF investors
The bond market may be ripe for a rally over an 18-month plus time frame if the inflation does not stray away from the RBIs comfort zone. While this may mean taking positions in long-dated funds, retail investors should be strictly guided by their time frame of investment, when it comes to investment in debt funds to avoid burning their fingers as was the case in mid-2013.

For those with a less than 1 year investment time frame ultra-short term and short-term debt funds would provide sufficient returns without taking undue risks or enduring volatility.

For investors building a long-term portfolio or those with a time frame of 2 years and above, income funds that have a mix of corporate and government bonds would provide sufficient opportunity to ride any price rally in bonds when rates fall. However, such a holding would mean flat returns in the short to medium term and hence not suitable for those seeking instant gratification.
The writer is the Head-Mutual Fund Research, FundsIndia.com

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