In its first bi-monthly policy RBI governor Raghuram Rajan reduced the repo by 25 bps although the market expectation was higher but still he cheered the market by his shift in liquidity management policy. RBI’s liquidity management policy will ensure better results and even real effect on market will be more than 25 bps.
With this 25 basis points cut the cumulative reduction in repo is 150 basis points since the beginning of 2015. But in spite of that banks were unable to pass on the reduction because of liquidity crunch in the market and only 70 bps reduction was passed on by banks. Tight liquidity was one of the main reasons behind that. This time RBI has tried to address the real problem.
Liquidity measures: The central bank has acknowledged liquidity management in two ways: short term and permanent durable liquidity, in line with broad market thinking. In this regard the RBI’s commitment to lower the average ex ante liquidity deficit from 1% of demand and time liabilities to close to neutral over a period of times is very important as it will reduce the gap between call money rate and repo rate.
With deposit growth at 50 years low Rajan has softened the penalties on banks for extra borrowings from RBI. The part of customer deposits that banks have to mandatorily park with RBI is reduced to 90% from 95%.Extra interest rate charged to bank for borrowing above their quota is reduced to 7% from 7.75%.
Apart from this RBI has ensured its open market operations to infuse liquidity into the market. It will buy bond
Buying bonds from open market: This cheered the bond traders in spite of less than expected reduction in repo. RBI has assured its operations in bonds market. Some experts believe that RBI can buy at least 1 lac crore value of government bonds this year. This will lead bond yield to dip and their priced will push.
Opportunities in liquid funds: Investors looking to park their excess money in debt instrument are looking for debt funds that put their money in short term papers. Gilt the dynamic bond funds have already seen 3-4% appreciation since the start of this year. Fund managers believe that there is room for 25 basis point cut in coming months as RBI has also reiterated that it is open for further rate cut in near future. Investors are suggested by the experts to park their money in short term funds now.
Let us have a quick look on type of debt funds and average duration of securities in which they invests:
Liquid funds: They have time frame of 1day to 3 months. They have short term investing cycle so they will be the first choice of investors in after the RBI policy.
Ultra-short/ short term funds: These funds invest in CP’s, CD’s, and bonds with maturity of 6 months to 5 years. Market has expectation of one more rate cut of 25 basis points so these funds can generate decent returns.
Dynamic Bond funds: These funds invest in Bonds, corporate papers and government securities. These funds have a time frame of 6 months to 5 years. Investors having long term view are only suggested to invest here.
Income/gilt funds: These funds invest in bonds, corporate debentures and government securities. These funds have a time horizon of 3-5years.Investors are advised to shift their holdings from gilt funds to liquid funds as with end of repo cycle they won’t be able to fetch decent returns.
Reduction in home loan and deposit rates: banks are considering reducing the rate on deposits but they are not in mood to reduce the home loan rate right now. It will take time to pass on the RBI’s rate cut. But after a lag of time a considerable reduction can be expected. But Bank’s shift to MCLR from Base rate method will avail the rate reduction for fresh loans only. So you may have to restructure your loan or pay it and take a fresh one.
It was a good policy and nice initiatives are taken by RBI which will result in better return in liquid funds, better growth, and reduction in borrowings rate and end of the era of liquidity crunch in the system. Hope you will find this information and analysis use full. For further improvement or queries I can be reached via whats app at 9953077844 or via e-mail at email@example.com.