| Credit Policy- Impact on Bond Funds |
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The central bank has had to achieve a balancing act of containing Inflation without sacrificing growth. Sacrificing growth would mean increasing interest rates that would slowdown the economy, but would in turn moderate the demand for goods and services and keep inflation in check. So far the RBI’s actions have been as follows.
The inflation scare cropped up in third week of March when reported numbers where way above the central bank’s 5 per cent, comfort level. As of March 29 (inflation numbers are reported at a lag of 14 days) annual inflation was reported at 7.41 per cent.
The RBI raised the Cash Reserve Ratio or CRR by 50 basis points on Thursday, April 17, after market hours. This would effectively suck out excessive liquidity from the system. Barely 12 days later, at its credit policy review scheduled on April 29, another CRR hike of 25 basis points has been announced, which will be effective from May 24. The CRR after May 24 will stand at 8.25 per cent.
What is more important than the CRR hike is that other key lending rates, the bank rate, repo and reverse repo rates have been left unchanged. This has brought much needed relief to the economy. The CRR hike will mean that banks will become choosy about whom they lend money to, but they will not increase their Prime Lending Rates.
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While the former rate hike on April 17 was expected by most, the timing of it did take investors by surprise and bond prices had not yet corrected sufficiently. As a result on Monday, April 21, the yield on the 10-year benchmark bond rose seven basis points to end at 8.19 per cent. And the average short-term debt fund rose 2.25 per cent (simple annualised) on April 21. As always, the long term debt fund category that hold longer dated papers saw a much bigger setback. These funds suffered an average loss of (-) 2.84 per cent (simple annualised) on April 21. The maximum loss was suffered by DBS Chola Triple Ace – Regular fund that fell (-) 84.79 per cent, simple annualised. This is rather surprising, since the fund’s average maturity was below what the average peer maintained in March. The biggest losers in the long term bond fund category where the funds that maintained an average maturity of five or more years.
RBI was slated to review its credit policy on April 29. While few expected an increase in key rates, sentiment was definitely jittery. But by the morning of Tuesday, April 29, traders were more and more certain that key lending rates will remain unchanged, especially since the US Federal Reserve is widely expected to revise its key lending rates downwards by Wednesday evening. As a result the yield on the 10-year benchmark 8.34 per cent GOI bond was trading at 8.06 per cent just before the credit policy announcement - down eight basis points from its previous close on Monday.
But once the credit policy was announced, relief swept the market. The fact that RBI had left key rates unchanged led the 10 year benchmark on a rally with heavy volumes. The yield on the 10 year bond fell 20 basis points! And closed at 7.94 per cent on April 29. The CRR hike left the market unfazed.
The improvement in the returns of the bond funds was also apparent, with the average one-day return of the long term income fund rising by 93 per cent (simple annualised). DBS Chola Triple Ace – Regular was the best performer, and managed to make good its losses on April 21.
A downward revision of key lending rates seems distant; inflation will be monitored very closely for any cues on what the central bank might do. |
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