RBI kept key policy rates unchanged at the 7th December policy meeting. The Repo rate remains at 6.25% and the Reverse Repo Rate remains at 5.75%. This was despite a consensus view from almost all market participants who were expecting a rate cut of at least 25 basis points in the key policy rates.
RBI also decided to restore the Cash Reserve Ratio (CRR) at 4%, thus reversing its decision, from around a ten days back, when they had temporarily increased the CRR rate.
In other important announcements, RBI reduced their forecast for FY17 Real GVA (Gross Value Added) by 50 bps to 7.1% from 7.6% earlier. RBI has also kept their inflation target unchanged at 5% by Q4FY17 and the medium-term target of 4% (+/-2%).
Our Assessment on the impact of the RBI key decisions:
- Notwithstanding near-term corrections because of the unexpected RBI decision on key policy rates, Bond yields are expected to go down in the next 3–12 months. Falling yields will result in rising bond prices.
- The CPI inflation may be lesser than the RBI target of 5% by March 17th, 2017
- RBI will have ample room to cut policy rates this financial year and is most expected to do that now in their scheduled February 2017 review meeting.
- With overall increased liquidity and funds for the banks, they could lower lending rates and pass on the benefits of lower cost of funds.
- Fixed Deposit rates are also expected to go down in this financial year.
- We do not agree with RBI that the GDP impact of demonetization would be as short lived as they have projected. We advise customers to continue to have a cautious approach on equities.
In conclusion, the markets participants’ consensus of gradual lowering of bond yields (and increasing bond prices) remains intact. Only the process seems to have been somewhat delayed by the RBI decision to adopt a wait and watch policy on key policy rates. Clients can stay invested in their debt mutual funds!