The policy:
The RBI reviews data understands risks and prepares the economy for anticipated changes. On the surface, it may appear that the reserve bank didn’t do much in its October policy. However, leaving things unchanged reflects careful consideration. Inflation and growth will decide interest rate movements.
Inflation is proving to be tricky. In the last two months, it has climbed from historic lows. Its trajectory is unclear. Increased expenditure through State Developmental Loans and the implementation of the 7th Pay Commission could push inflation up. Potential farm loan waivers, food inflation, oil prices, credit growth, and geopolitical tensions could heavily influence the inflation trend. Although the estimate has been revised upwards, it remains within the RBI’s medium-term target of 4% +/- 2%.
The services sector is showing promise and there is positive news in the manufacturing space as well. Yet, deficient rainfall and depleted water reserves remain a concern for agriculture. Therefore, growth continues to remain elusive.
Investment Strategy:
The repo rate is at 6%. The Reserve Bank continues to maintain its neutral stance, despite pressure to cut rates. A reasonable return expectation from fixed income instruments would be 7.25% to 7.5%. A higher return would require compromise on credit quality.
Yields in duration funds are indicative of market expectations. As we approach the end of the rate cut cycle, longer-term securities carry a higher interest rate risk. Ultrashort-term and short-term debt funds are a sensible investment option. Accrual funds with run down maturity can protect invested capital.