The RBI’s stance of calibrated tightening indicates that rate hikes are possible but not mandatory. As investors, it is important to capitalize on rising yields to structure a layered portfolio. The spread between the repo rate and the 10 Year Government Security is nearly 1.5%. This presents a compelling investment opportunity as it is normally 0.5% to 0.75%.
The last two months have been eventful for financial markets. September witnessed tight liquidity conditions, the default from IL&FS, a new milestone in the NPA resolution process, new lows for the rupee, and much more. All these factors have made bond investors wary of the bond market. Recent volatility and correction of financials in equity markets has raised investor concerns across the board.
Defaults have risen from “asset-liability mismatches”. This is when companies borrow money for long-term projects using short-term instruments to reduce the cost of borrowing. The capacity for these assets to generate cash in the short-term is limited and could trigger defaults and destabilize the financial system.
The RBI Policy:
Market consensus indicated that the RBI would raise the repo rate by at least 0.25% in its October meeting. However, they left the repo rate unchanged and modified their stance from neutral to calibrated tightening. This surprised participants, since rate hike expectations were already factored into the bond prices.
Interest rates are not the only way the central bank can stabilize markets. To address illiquidity, the RBI conducted OMO purchases and reduced the SLR [Statutory Liquid Ratio]. Inadequate liquidity creates panic and reduces financial stability.
Recent inflation prints have been below the targeted 4%. However, rising oil prices, the upcoming festive season, and increased liquidity could push it up.
The Way Forward:
It is important to note that the rupee has not been as severely affected as its peers. Domestic macroeconomic indicators remain promising. Growth has exceeded forecasts and inflation is largely contained. The real concern is to protect this stability and build resilience towards global threats. By controlling inflation, remaining fiscally prudent, creating appropriate capital and liquidity buffers, and continuing structural reforms, economic resilience can be sustained. A stable economy attracts investments and promises growth.