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RBI move signals a lower interest-rate regime

Aabhas Pandya

The cut in bank rate and cash reserve ratio, or CRR, will give a fillip to the net asset value of debt and gilt funds, with prices of debt securities recording sharp gains.

The Reserve Bank of India, or RBI, cut banks' CRR to 8 per cent from 9 per cent on Saturday, coupled with a 1 per cent cut in bank rate from 8 per cent to 7 per cent with effect from April 1.

However, the cut in CRR will come into effect in two tranches of 0.5 per cent, each from April 8 and April 22.

"Though prices are lower than Saturday's levels, we are still going to end with a gain of Rs 2 and more towards the long-end of the gilts market. There was heavy selling by primary dealers in the market today, which saw prices retracting from Saturday levels," said a debt fund manager.

"While the cut in CRR will add liquidity to the system, it is the cut in the bank rate which signifies that interest rates are headed southwards," added Akhilesh Gupta at Dundee Mutual Fund.

The 1 per cent cut in CRR will release close to Rs 72 billion in the system. Besides, the RBI cut the repo rate to 5 per cent from 6 per cent, with effect from April 3. The rate on savings deposits with banks has also been brought down by 50 basis points to 4 per cent.

While the reduction in bank rate and CRR will soften interest rates in the immediate future, the government's huge gross borrowings programme of Rs 1.16 trillion is a worrying factor.

In the event of a pick-up in credit demand from the corporate sector, coupled with government's huge borrowings, there could be tightening of liquidity and some hardening of interest rates.

"While the government is expected to be in the market in the first week of April itself, an important key to low interest rates will be foreign investments and inflation level," says a fund manager.

The cut in CRR and bank rate has come as a big relief to fund managers, who were turning jittery due to lack of a clear direction from the RBI and this was beginning to impact the sentiment.

Besides, funds were faced with a deluge of redemption from corporate investors, which forced them to liquidate holdings and led to a drop in the net asset values.

However, the extent to which a fund will benefit from the cut in CRR and bank rate will depend on the maturity profile of the underlying securities.

The funds, with large investments towards the long-end of the market, will gain the maximum, while funds invested largely towards the short-term of the market will pocket only small gains.

Some funds had reduced the average maturity profile of their portfolio after the market had turned cautious due to the government's large borrowings programme and absence of a clear signal from the central bank.

While debt and gilt funds will gain in the immediate future due to an appreciation in their underlying investments, in the long run, returns from debt funds will come down and make them a less attractive investment avenue.

The debt funds are expected to lose a part of their inflows to conservative balanced funds like monthly income plans that generate higher returns with a 15-20 per cent exposure to equities. Some investors could also move to balanced funds with a little over 50 per cent exposure to equity.

Source: Value Research

Mutual Funds

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