The Reserve Bank of India surprised the markets by holding rates unchanged and changing its stance of monetary policy from accommodative to neutral. The benchmark overnight repo rate was left at 6.25%. Back in December, the RBI had held rates unchanged, but had signalled an accommodative stance indicating the possibility of future rate cuts.
The hawkish change in stance has come during a time when we have not seen any significant upside risk to growth or inflation, thus taking the market unawares. In response, bonds fell – with the 10-year government bond yield rising by about 25 basis points to 6.69% from 6.44% just before the policy announcement.
In the wake of demonetization of high value currency notes in November, there has been a significant drop in inflation – chiefly led by a fall in vegetable prices. Some of this is likely to be distress sales thus potentially providing some upside risk to inflation in the months to come. In addition core inflation – inflation other than in food and fuel – has continued to be sticky just below the 5% level. To RBI this suggests that the medium term outlook for inflation is higher than the 4% level it is targeting.
The impact of demonetization was judged transient from the growth perspective also. The pace of remonetization has been quick and the RBI further relaxed cash withdrawal norms from savings accounts. This in conjunction with an improving global growth outlook also argues for reduced monetary accommodation.
We have previously argued that RBI is close to the end of the rate cut cycle. Today’s neutral stance supports this view. In this context we believe that short bonds are likely to outperform long bonds going forward. Money market and short term bonds are also beneficiaries of the abundant banking system liquidity following demonetization and are relatively insulated from the risks of global rates and inflationary pressures.
The RBI’s focus on controlling inflation in the medium term provides some opportunities too. If inflation is indeed contained to 4% on a sustainable basis, yields can drop materially over the next couple of years. While rates may remain elevated in the near term, this may prove very attractive with a slightly longer term investment horizon.
In recent months we have reduced duration across our fixed income funds and we expect to further hold a lower duration stance across the portfolios.
This document represents the views of Axis Asset Management Co. Ltd. and must not be taken as the basis for an investment decision.
Neither Axis Mutual Fund, Axis Mutual Fund Trustee Limited nor Axis Asset Management Company Limited, its Directors or associates shall be liable for any damages including lost revenue or lost profits that may arise from the use of the information contained herein. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The material is prepared for general communication and should not be treated as research report. The data used in this material is obtained by Axis AMC from the sources which it considers reliable. While utmost care has been exercised while preparing this document, Axis AMC does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Investors are requested to consult their financial, tax and other advisors before taking any investment decision(s). The
AMC reserves the right to make modifications and alterations to this statement as may be required from time to time.
Axis Mutual Fund has been established as a Trust under the Indian Trusts Act, 1882, sponsored by Axis Bank Ltd. (liability restricted to Rs. 1 Lakh). Trustee: Axis Mutual Fund Trustee Ltd. Investment Manager: Axis Asset Management Co. Ltd. (the AMC) Risk Factors: Axis Bank
Limited is not liable or responsible for any loss or shortfall resulting from the operation of the scheme.
Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.