RBI Raises Reverse Repo By 25 bps, Leaves Repo Rate Unchanged

In line with broadly held expectations, the RBI left repo rates unchanged at 6.25 per cent in yesterday's bi-monthly Monetary Policy Review. However, it did hike the reverse repo rate by 25 bps to 6 per cent, thereby narrowing the policy rate corridor from 50 bps to 25 bps. The reverse repo rate is the rate at which the (Reserve Bank of India borrows money from commercial banks. The objective of this move is to anchor the weighted average call rate closer to the policy repo rate, reducing volatility and improving the transmission of monetary policy rates across the spectrum.

On the inflation front, the policy cited evenly distributed risks now. The key upside risks stem from the one-off impact of the GST implementation, uncertain monsoons, and the inflationary effects of implementing the 7th pay commission. However, easing international crude prices are expected to temper down headline inflation.

The RBI also stated that it anticipates a sharp recovery in the growth trajectory in 2017-18 on the back of five factors. Firstly, domestic discretionary spending is expected to rise, as the pace of remonetization gathers impetus. Second, transmission of rate cuts into bank lending rates is expected to stimulate consumption demand. Third, economic activity is expected to get a boost from the infra and capex thrust of the Union Budget proposals. Fourth, efficiency gains arising from increased investor confidence owing to the GST implementation and the abolishment of the FIPB are expected to rise. And last, the spurt in IPO activity which could boost capital market inflows.

What are key takeaways for fixed income mutual fund investors from yesterday's policy announcements? Considering the quick swings in global macro indicators and volatile political and fiscal set up, upside risks to inflation do remain. The Fed rate hike trajectory, global growth momentum and political developments are three key factors that need to be closely monitored. We may even see the RBI adopting a more hawkish stance in the times to come, and yields are more likely to stay range bound between 6.5 per cent and 6.9 per cent in the near term (it stands at 6.82 per cent today). Debt Fund investors are advised to stick with high quality accrual based funds with a low to average modified duration ranging from 1 to 3 years. Those with a longer time horizon of at least 3 years may consider investing into dynamic bond funds.