Fixed Income: RBI Policy Review Coming, Invest In Liquid Funds Just Before April 6

Invest in liquid funds just before April 6 as these are least volatile. Shift to ultra short-term funds later as per your investment needs.

For tracking your investments, you need to be aware of the events in the underlying market. However, each and every event does not necessitate an action, i.e., you need not reshuffle your portfolio after every event. The forthcoming RBI Policy Review meeting is one such event. We will discuss its relevance on existing investments and fresh investments. First, let’s see what the event is. Status quo expected on April 6.

This financial year (2017-18), the RBI Monetary Policy Committee (MPC) will meet six times to discuss and decide on the direction of monetary policy. The committee gives its outlook on GDP growth, inflation, etc., and most importantly, signals on interest rates. In the last meeting on February 7-8, the MPC changed its stance on interest rates from ‘accommodative’ to ‘neutral’, meaning there would not be any further reduction in signal interest rates, i.e., overnight repo rate, unless there is a compelling reason. The next review meeting is scheduled for April 5-6. It is expected that the RBI will maintain status quo on interest rates in the meeting.

Another measure that is expected to be announced on April 6 is on banking system liquidity management. Banking system liquidity is measured by the amount of surplus funds parked by banks with the RBI under reverse repo window, net of funds availed under repo. Currently, the surplus is approx `4 lakh crore, which is much on the higher side, that too after March advance tax payments. To bring it down to reasonable levels, the RBI may announce some measures. It may be a conventional measure like CRR hike, or they may introduce a new mechanism, such as standing deposit facility (SDF) which would not require a collateral as in case of repo/reverse repo.

State of economy
After the previous MPC meeting on February 8, market reacted sharply and yields went up by approximately 40 basis points (0.4%) and prices of bonds came down proportionately. This kind of reaction is unlikely on April 6, as the market has already gone through the change of stance from ‘accommodative’ to ‘neutral’. If at all, there may a word or two hiding between the lines of the policy statement indicating that the RBI is happy with the current state of the economy and interest rates.

Of late, yield movements in the bond market has been positive with strengthening rupee and government borrowing programme for the first half of the year being as per expectations. The reaction to the review on April 6 would not be much, even if it is mildly positive for the market, in view of the movement that has happened over the last few trading days.

Impact on investments
Now let us look at the impact on your investments. For long term investments, you need not worry about day to day movements, stay put. Every day, there will be some market movement for some reason. Some proactive investors tend to enter bond funds when there is an impending event and it is expected that yields would move up subsequently, giving a better entry level (lower NAV of the fund). However, if the market movement is not significant, it does not help much over a long horizon. On the flipside, you may get caught on the wrong foot.

If there is any measure for sucking out liquidity from the banking system, there would be a negative reaction in money market instruments, i.e., yields on instruments of very short maturity like certificates of deposit (CDs) and commercial paper (CPs) would move up, resulting in a minor adverse impact on your fixed income funds. However, the impact is likely to be temporary. With the onset of the new financial year, government expenditure will start in full swing, adding to banking system liquidity. This year, the Budget being passed well in advance will help government expenditure. Hence nothing much to worry on that front.

For fresh investments, as long as you have an adequately long horizon, a minor differential at the entry level will be evened out over the long investment period. Ultra short term funds may face a little volatility if banking system liquidity is tightened in the review, hence it is advisable to invest in liquid funds just before April 6, as liquid funds are least volatile. Afterwards, it may be shifted to ultra short term / money market funds as per investment objectives and horizon.


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