Impact of the recent monetary policy on debt mutual fund schemes
1. 1
Mutual Fund Analysis October 29, 2011
Impact of the announcement of 2nd Quarter monetary policy on debt mutual fund schemes:
As widely expected, the Reserve Bank of India has upped the key short term rates – Repo and Reverse Repo by 25
basis points each at its Second Quarter review of monetary policy for 2011 – 12 on October 25, 2011 to curb
persistent inflation, which remains above the comfort level.
Highlights:
• Hikes repo rates 25 bps to 8.50%.
• Reverse Repo rates goes up 25 bps to 7.50%.
• Marginal Standing Facility is set at 9.50%.
• Bank Rate and CRR rates kept unchanged at 6%.
• Deregulates savings bank deposit rate with immediate effect.
• FY 2012 GDP projection revised downwards to 7.6% from 8%.
• March end inflation projection retained at 7%.
• Inflation to moderate below 7% in H1 2012-13.
• FY 12 Money supply growth projection maintained at 15.5%.
• Non-Food Credit growth projection maintained at 18%.
This is the 13th hike since March 2010 with the cumulative increase of 525 bps in the repo rate aiming to anchor
inflationary expectations, stimulate investment activity, reinforce emerging downward inflationary trajectory
and ensure liquidity is in moderate deficit.
The RBI hinted that the present rate hike could possibly the last in the current interest rate cycle as inflation
could start come off from the current level of 9% and above by December.
For instance, the RBI projected that the inflation will cool off and touch 7% level in March 2012. And it
reiterated its medium term objective of monetary policy to contain inflation at 3% level.
Impact of recent monetary policy on debt schemes Retail Research
2. 2
Mutual Fund Analysis contd…
Inflationary concerns: Even though the demand side inflationary pressures are expected to cool off due to
global economic slowdown that affects investment and consumption demand, the supply side constraints such as
instability in global commodities prices and domestic fuel price hikes elevate the pressure on inflation. Rising
global crude oil prices is also a present threat to inflation expectations.
WPI Inflation Vs. Repo Rate
13
WPI Inflation (RHS) Repo Rate (RHS)
11
9
9
7
6
5
3
3 1
Jan-10
Feb-10
Mar-10
May-10
Jun-10
Jul-10
Oct-10
Nov-10
Dec-10
Jan-11
Feb-11
Mar-11
May-11
Jun-11
Jul-11
Oct-11
Sep-10
Sep-11
Apr-10
Aug-10
Apr-11
Aug-11
Bond Market: As far as fixed income market in India is concerned, the yields of the bonds have been under
intense upward pressure over a year where prime factors such as heightened global uncertainties, sharp rupee
depreciation, weak Govt finances, higher Govt borrowing, tight liquidity conditions, instability in the global
commodities prices, rate hike in the wake of persisting inflation, and significant growth risks weigh the
sentiments over the short term.
Indian bond market got a respite and cheered a bit post policy announcement as the rate hike was in line with
the expectation. However, the market will take cue from the government borrowing, liquidity and global
concerns going forward.
Impact of recent monetary policy on debt schemes Retail Research
3. 3
Mutual Fund Analysis contd…
Global uncertainties such as concerns on growth slowdown in the US, debt overhang situation in the Euro zone
nations, increased inflation level that is relatively high in the emerging economies like China, Brazil and others,
clearly indicate the downtrend in the growth spectrum over the global front. All such worrisome factors have a
negative impact on the Indian economy.
Potential benefits from the recent decline in global commodities prices have been offset by the sharp
depreciation in the rupee against the US dollar.
There has been tight liquidity condition prevailing in the system for months. Liquidity that is measured by LAF
window witnessed deficit of around Rs. 53,500 crore on a daily average basis for last six months period.
The projection on GDP growth for FY 12 which has been revised to 7.6% against initial estimate of 8% clearly
indicates the slowdown in India’s economic growth.
The overhang of bond supply (that is visible in the increase in the borrowing figure for 2011-12 by Rs. 53,000
crore) and probable slippages in the fiscal deficit numbers also influence the market.
India GDP Growth Rate (%):
11
10 9.6 9.7
9.3 9.4 9.4
8.8 8.9
9 8.5 8.6
8.3
7.8 7.8
8 7.5
7.7
7.3
7
6.3
6.1
5.8
6
5
Mar-07
Jun-07
Dec-07
Mar-08
Jun-08
Dec-08
Mar-09
Jun-09
Dec-09
Mar-10
Jun-10
Dec-10
Mar-11
Jun-11
Sep-07
Sep-08
Sep-09
Sep-10
Impact of recent monetary policy on debt schemes Retail Research
4. 4
Mutual Fund Analysis contd…
.
Deregulation of the savings bank deposit rate: The RBI also announced the deregulation of the savings bank
deposit rate with immediate effect. With this, banks are free to determine their savings bank interest rate
subject to conditions. This will push up funding cost for banks and impact their earnings (and may be passed on
the borrowers). A possible increase of 100 to 200 bps in the savings bank deposit rates may affect the inflow into
the liquid mutual funds going forward.
Conclusion: Considering the above, we are of the opinion that the present scenario in the market is likely to
continue at least for next three months. The yields of bonds including money market instruments are expected
to remain at the present level or inch down by up to 100 bps in the near term. Investors are advised to stick
with the present strategy of investing in the short term mutual fund categories like liquid, ultra short term and
short term income.
As interest rates seem to have peaked out (except a small chance of them rising further due to fiscal slippages)
investors can allocate part of their corpus in a SIP manner in Income / Long term gilt funds over the next six
months to benefit out of an impending fall in interest rates (whose timing is uncertain at this point and hence
the SIP advice). When interest rates start dropping, income & LT Gilt funds appreciate the most due to their
longer average maturity and exposure to long term papers.
Analyst: Dhuraivel Gunasekaran. Database sources: RBI & Newspapers
HDFC Securities Limited, I Think Techno Campus, Bulding –B, ”Alpha”, Office Floor 8, Near Kanjurmarg Station,
Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Phone (022) 30753400 Fax: (022) 30753435
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Impact of recent monetary policy on debt schemes Retail Research