The Reserve Bank of India (RBI) decided to further reduce the policy repo rate under the Liquidity Adjustment Facility (LAF) by 25 basis points, along expected lines, in Thursday’s policy announcement. The policy stance remains “neutral". Consequently, the repo rate under LAF stands at 6%, and the reverse repo at 5.75%. The debt markets reacted negatively as markets sold off across the curve. The 10-year benchmark government securities (G-secs) ended the day at 7.34%.
RBI cited lower-than-expected inflation and gross domestic product (GDP) growth estimates from the Central Statistics Office (CSO) as reasons for the latest policy action. Weaker-than-anticipated global outlook and concerns on contraction in global manufacturing were secondary reasons. RBI’s dovish stance is now in sync with other central banks across the developed world.
As part of the Developmental and Regulatory Policies, there were some notable developments. RBI has permitted banks to use an additional 2% of high-quality assets (largely G-Secs), within the mandatory SLR (Statutory liquidity ratio) requirements, as the Facility to Avail Liquidity for Liquidity Coverage Ratio (FALLCR), in a phased manner. This will ensure that banks have sufficient high-quality liquid assets for lending purposes.
Also, the move to allow non-banking finance companies (NBFCs) to apply for an “authorized dealer licence" may be seen as a precursor to further deepening the currency markets. Another interesting but expected move was to defer the implementation of market-linked loan disbursal regulation, given the logistical issues and concerns by stakeholders over its implementation.
RBI, in its February policy, echoed the need to stimulate domestic growth. Given the weak global outlook, RBI has proactively added durable liquidity to the system, to facilitate growth and latent demand.
The markets had anticipated guidance on liquidity flow, but the governor remained silent on this front. Last year, open-market operations played a key role in guiding rates across the curve. Over the two monetary policies since the start of 2019, RBI has cut rates twice. This has effectively anchored 10 year G-sec yields at 7.30% levels. While long-tenor bonds may offer tactical opportunities, we prefer short-term tenor bonds for our core portfolio.
High policy and repo rates have created a large wedge between them and Consumer Price Index-based inflation. We believe that this is a short-term phenomenon which should correct over the next few quarters. We see the inflation wedge as a short-term opportunity to add duration selectively to our portfolios given the current risk-reward on the medium to long end of this curve. We also re-emphasize our view of credits. Given that the attention of market participants has been skewed towards the AAA segment in the short space, credits in the same space (one to three years) offer significant opportunities.
We have selectively added duration in our portfolios through long bonds. We have also added select one-three-year AA credits across our credit portfolios in line with our credit view. The corporate bond spread in the short- to medium-term space also offers material opportunities for buy-and-hold investors.
R. Sivakumar is head, fixed income, at Axis Mutual Fund.