Post the announcement of RBI’s policy yesterday, the 10 yr benchmark G-sec softened by 19bps as the key policy rates remained unchanged. However, it gave up all its gains during the day and ended up at 8.24%, 11 bps higher than the previous day’s closing. Interbank call rates remained at 10 – 10.10 levels. Three months CDs remained unchanged at 10.93 % levels and the spread between CP was at 57 BPS.
Surprisingly, the one year CD yields came off by 24 bps compared to the previous day at 10.32%. On the contrary, the yields on CPs inched up by 20 bps at 11%. Given the steepness at the shorter end of the curve, there is a strong case for investors to consider investing in a FMP (Fixed Maturity Plan) with a mix of CP/CD.
Although, the quarterly monetary review policy appears to be lacklustre, lots has been said regarding the burgeoning CAD, food inflation, Growth forecast, and lack of structural reforms to attract FDI. Since Rupee has strong linkages to inflation and CAD, the central bank has sharpened its focus on currency stability than growth. It was also vocal that their intervention to restore stability in the FX market should be construed as a window of opportunity for the Government to put in place policies and reforms to bring the CAD to sub 2.5% of the GDP.
Rise of the International crude oil prices coupled with a sharp depreciation of the rupee since May 2013 will add to the current high inflationary pressure. The immediate option for the government would be to contain the spending on subsidies (food, fertilizers, and petroleum) accounting for 2.5% of the GDP. But, there are serious doubts if government would consider this, with the Loksabha elections around the corner. The other option that is being widely talked about is the issuance of sovereign bonds to fund the CAD.
The Governor’s statement also highlighted considerable challenges on the growth front leading to downward revision in the growth forecast from 5.7% to 5.5% and concern about the lack of clarity if the financial markets have factored in the full impact of the prospective tapering of QE.
The only silver lining is, RBI has indicated to roll back the liquidity tightening measures and return to more accommodative monetary policy focusing on growth, once stability is restored to the FX market. Given the current challenges, the prospects of a roll back in the next 6 – 12 months looks less likely. Investors are advised move their assets incrementally to Fixed Maturity Plans of up to one year to enable them to lock in their investment at these higher levels.