FROM DOVISH TO NEUTRAL STANCE BY RBI-MONETARY POLICY REVIEW JULY 28’2009

By · Tuesday, July 28th, 2009

Most of the market participants had expected RBI to maintain its Dovish stance on interest rates prior to the announcement of RBI Monetary Policy review today. However, RBI’s stance has changed slightly from Dovish to Neutral on the interest rate stance with a bias for it to inch upward in future.

RBI has maintained all key rates unchanged. Bank Rate remains @6%, REPO Rate remains unchanged @4.75%, Reverse REPO rate unchanged @3.25% & CRR unchanged@5%.

RBI has made following important Policy statements:

  1. Manage liquidity actively so that the credit demand of the Government is met while ensuring flow of credit to the private sector at viable rates
  2. Keep vigil on the trends and signals of inflation, and be prepared to respond quickly & effectively through policy adjustments
  3. Maintain monetary and interest rate regime consistent with price stability supportive of returning the economy to high growth

Hence, though from market perspective there were no surprises and the policy statements were both hawkish and dovish to make it a neutral stand on interest rates; RBI has upped its antenna on inflation front. This they admit might be a supply side issue, it still needs to be on their radar on an ongoing basis.

Policy was well discounted ahead of its announcements as was evident from 10 year benchmark yields which moved down slightly from 6.95% to 6.93% post the announcement. I feel ( as mentioned in my earlier notes), the benchmark will remain in a trading zone between 6.75% to 7.25% .

Path Going Ahead:

  • Long end to be in trading zone between 6.75% to 7.25%
  • Liquidity to continue with a possibility of RBI taking a call as & when inflation will start inching up
  • Credit spreads have compressed but have more scope in certain mid to long term segments with improving corporate results and access to raise funds through equity issuances due to better equity market performance
  • There will be a lot of issuances till March 2010 of State Govt papers; which will give opportunity of investing in this segment with spreads rising
  • Near term rates ( 0-6 months ) have fallen sharply on the back of excess liquidity. However, 2-5 year corporate bonds have not seen commensurate drop in yields
  • As a result spread between 90 days CD & 5 year top tier corporate bond has widened from 85 bps in December 08 to over 463 bps now
  • This gives a tremendous opportunity on the corporate yield curve upto 5 years which will be amply captured in the Short Term Plans
  • While investing in the Short end of the curve; keep an eye on the inflation and subsequent reactions of RBI ( in terms of sucking out liquidity etc)
  • DoT has made a statement today about postponing 3G Auction till such time issues faced by 2G spectrum are sorted out. This should have negative impact
  • Though Govt has announced a huge borrowing programme of Rs.4.50 lac crores in the Budget; most of it already being front loaded, it will be interesting to see how much Govt can spend from now to March & based on that how much lower they need to borrow ( with their track record of announcing major expenditure & not been able to execute the same & hence lower requirements to borrow). There might be a positive surprise on this issue

Current Shape of Corporate Yield Curve:

Maturity
Now

Dec-08
Change
3 mnth CD

3.32%

7.70%

-4.38%
2 year Corp Bond

5.95%

8.75%

-2.80%
3 year Corp Bond

6.95%

8.65%

-1.70%
5 year Corp Bond

7.95%

8.55%

-0.60%
Spread between 5 yr-3 mth

4.63%

0.85%

3.78%

CONCLUSION:

  • Stay invested on Short End of the Curve with an eye on RBI announcements on inflation concerns & liquidity measures. Take stock of situation around mid September before taking an exit call
  • Trade in long end between benchmark at 7.25% & 6.75% i.e. invest in Income/GILT above 7% & exit below 7%
  • Add on to Arbitrage as they are the only safe investment avenues without interest rate calls or market duration calls & can outperform liquid/liquid plus both on returns front & on tax arbitrage front
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