Note to fixed income investors – 06 Dec 2024

The Monetary Policy Committee (MPC) of the RBI, decided to keep the policy repo rate unchanged at 6.5%, eleventh pause decision in a row with a vote of 4:2. Consequently, the standing deposit facility (SDF) rate stands unchanged at 6.25% and the marginal standing facility (MSF) rate and the Bank Rate unchanged at 6.75%. The MPC also decided to continue with the neutral monetary policy stance and to remain unambiguously focused on a durable alignment of inflation with the target, while supporting growth.

Some of the key mentions in the policy statement

RBI in the recent past, on multiple occasions have proactively intervened to manage adequate liquidity in the banking system by conducting VRRR and VRR. With systemic liquidity expected to tighten in the coming months due to tax outflows and volatility in capital flows, the RBI decided to reduce Cash Reserve Ratio (CRR) by 50 bps to 4% in two equal tranches. This move is expected to release banking system liquidity of about INR 1.16 lac crores.

Markets reacted positively to this development as call money rate dropped by 30 bps to 6.25%. The 10-year benchmark G-sec yield hovered around 6.70%-6.71%. Indian Rupee has been under pressure lately, touching all-time low of INR 84.74/USD amid fund outflows. The central bank has been intervening in the forex market to support Rupee by selling USD. With the US Fed cutting rate by 75 bps so far and expected to cut rates further clubbed with RBI’s status quo on policy rate could help retain real rate attractiveness and support Rupee.

The current macroeconomic situation with GDP growth slowing to 5.4% in Q2FY25 and October CPI inflation print coming at 6.2%, has changed the growth-inflation dynamics, laying focus on bringing price stability with a close eye on growth. As a result, RBI made a downward revision to FY25 GDP estimate (6.6% vs 7.2%) and upward revision to CPI estimate (4.8% vs 4.5%). Going ahead, expectations of easing food inflation and pick up in government spending should help stabilize the growth-inflation dynamics which could possibly lead to a policy rate cut in rest of FY25.

The term spread between 3-month T-bill and 10-year G-sec has narrowed lately, although, the current spread of ~30 bps is still lower than the long-term average term spread of ~1.4%. This is expected to normalize further with improving banking system liquidity. The 10-year G-sec, in the short term, is expected to continue to trade in a range bound manner in the absence of any adverse event.

Strategy for fixed income investor

With expectation of policy rates coming down, G-sec yields offer a decent accrual and a possibility of participation in capital appreciation over twelve to eighteen months. However, with recent fall in yields the expected quantum of incremental capital appreciation has reduced. Long-term yield could remain sensitive to the evolving growth-inflation dynamics. Despite this, the current medium & medium to long-term yield levels appear relatively attractive and gradual increase in debt allocation could be considered, to benefit relatively more with anticipated moderation in yields.
Corporate bond spreads remain muted with AAA spreads still lower than the LTA amid lack of supply in the bond market. In select instances, spreads for AA and A appear attractive after adjusting for risk. Investor with an appetite for credit risk could start evaluating select high yield strategies.

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