RBI Monetary Policy and it’s Impact on Inflation & Growth.
One of the events that catch the fancy of investors every two months is the monetary policy announced by the Reserve Bank of India (RBI). Every two months, the Monetary Policy Committee (MPC) of RBI meets to determine the monetary policy for the economy that is altered with the help of interest rate and is determined based on the economic situation including growth and inflation.
On February 07, 2018, the MPC decided to keep the policy repo rate unchanged 6.0 percent and reverse repo rate at 5.75 percent. The MPC held a neutral stance of the monetary policy with the objective of targeting inflation within the prescribed limits of 2-6% over the medium term while supporting growth agenda.
Since the last MPC meeting in December 2017, there has been a significant development in the global economic activity. Developed economies such as Euro and Japan expanded with consumption revival and improving the investment climate, the US lost momentum due to the slowdown in Q4 of 2017 despite manufacturing supporting with the multi-month high in December 2017. For emerging markets, the economic activity, in the last quarter of 2017, was supported by Chinese growth that surpassed estimates on the back of strong domestic consumption and robust exports. Crude oil prices touched three year high due to cut in production by the OPEC countries coupled with falling inventories that weighed on the global demand-supply situation. This resulted in benefit for countries like Russia. Household spending and unemployment turned positive for Brazil while South Africa continued to face challenges on both domestic and external fronts. Financial markets turned volatile with the uncertainty around the pace of normalization of the US Fed monetary policy. The volatility index (VIX) also climbed to its highest level while equity market started to witness correction for both developed and emerging economies. This impact translated to the bond yields in the US and other economies.
On the domestic front, the advanced estimates revealed marginal deceleration in the growth on account of a slow down in multiple sectors including agriculture, mining and quarrying among others. Retail inflation increased during December due to the implementation of 7th central pay commission (CPC).
Outlook on inflation and growth
Inflation, over the medium term, will be certainly determined by international crude oil prices, prices of non-oil industrial raw material, monsoon 2019. Similarly, economic growth will be impacted by stabilization of GST implementation, revival in investment activity credit off-take, resource mobilization. It will be supported by capital goods production and imports, and recapitalization of public sector banks.
Impact of bond yield & Monetary Policy
Monetary policy determines interest rates that in turns determine the risk-free rate of return. This risk-free rate of return impacts not only bond yields but also many other financial instruments. The sixth bi-annual monetary policy meet concluded on February 7th, 2018 resulted in a lot of uncertainty around the bond market as the bond yields for 10-year g-sec yield (benchmark) has grown to reach 7.5 percent.
Image source: LiveMint
The MPC did not really cut the rate and maintained a neutral stance but the commentary from the MPC and the inflation target very well indicated that the RBI is fearing rising inflation in near future which shall trigger a hike in interest rate. Any rate hike in the short term could result in bond yield sustaining elevated levels.
Further, given that the bond price and yields move in opposite direction, rising-yield has resulted in bond price going down for long-term bonds. Hence, for the debt mutual funds, declining bond prices of underlying holdings have been impacting the return that is a function of changing bond price.
Rising bond yield also had a ripple effect on the equity market where the concern is raised around the corporate earnings that may get impacted due to the interest rate. Further, sustenance of higher bond yields results in institutional money getting shifted out of equity.
To conclude, we, at WealthTrust, believe that an investor should ideally reduce his/her exposure to debt market currently particularly the long-term debt funds. At the same time, we also believe that given India’s fundamentals remaining intact, an investor should hold on to their equity positions over the long term.
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