RBI holds rates; What should debt mutual fund investors do?

The Reserve Bank of India held its policy rate in its monetary policy review held today in line with market expectations.

The Reserve Bank of India held its policy rate in its monetary policy review held today in line with market expectations. The repo rate, or the rate at which RBI lends money to banks looking for cover their short-term fund mismatches, currently stands at 4%. A pause on rate cut is considered bad news for debt mutual funds, especially long-term debt mutual funds. What should debt mutual fund investors do now?

The six-member monetary policy committee (MPC), headed by RBI governor Shakikanta Das, kept repo rate untouched at 4 per cent; and reverse repo rate at 3.35 per cent. "Global economic activity has remained fragile; surge in COVID-19 cases has subdued early signs of revival," the RBI Governor said. ETMutualFunds.com had reported on August 5 that the central banker may be pause on rate cuts. For more, read: RBI to pause on rate cuts?

Most money market participants, including debt mutual fund managers, were equally divided between a pause on the policy rates and a 25-basis-points (100 basis points = 1%) cut. RBI had already cut policy rates by 115 basis points in this year, but most money market participants were not expecting a rate cut because average inflation remained above RBI’s upper threshold.

“On an average Inflation has been above the RBI’s upper threshold of 6% in the last three quarters. Though we believe the headline CPI would come down in the coming 2-3 quarters, it’s recent stickiness above 6% mark could still weigh on the minds of the MPC members in the upcoming meeting,” said Pankaj Pathak, debt fund manager, Quantum Mutaul fund, who expected the the RBI will maintain a status quo on.

Kumaresh Ramakrishnan - CIO-Fixed Income, PGIM India Mutual Fund, also predicted that the RBI may pause. “I believe it is a very close call this time. Market is not factoring in a deep cut. We are expecting either a pause this time or at max a small cut of 25 bps,” he said.

Ramakrishnan also said that the headline inflation has been above the upper limit set by RBI. “Also, the market has seen some recovery in the past two months. So, this is possible for RBI to hold the rates now and use the room later if need be,” he adds.

Pathak was of the view that the future rate cuts would be dependent on `growth inflation dynamics’ and policies adopted by the government to address the growth challenge. He cited the recent government policies of increased taxes on fuel items and intoxicants that have been one of the factors that has kept inflation at elevated levels in the past few months.

“The RBI will also be carefully watching the policies on external trade front particularly in the wake of government’s objective of achieving self-sufficiency. Rising import duties could push up inflation over the medium term,” he said.

Ramakrishnan believed there is room for RBI to cut rates in the future. Also, RBI may look at widening the policy corridor by easing reverse repo rate, he said.

“I don’t think that debt market will react to the policy too much unless it is something totally unexpected. Yields have been pretty stable in the past and I think market has factored in a pause or a small cut. Our advice to the mutual fund investors remains the same. Stick to shorter duration, AAA funds. Corporate Bond Funds, Banking and PSU Funds are good options,” said Ramakrishnan.

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