For a horizon of, say, 1-3 years, it is preferable to opt for a short portfolio maturity so that volatility would be lower.
The RBI continues to do “whatever it takes” to fight the COVID-induced economic slowdown. For the third time in less than two months, the RBI has come forward with rate cuts and liquidity inducing measures. Let’s take a look at the salient announcements made today.
The macro numbers
-Repo rate reduced by 40 basis points from 4.4 per cent to 4 per cent. Along with the cut on March 27, today’s, repo reduction has meant an easing of rates by 115 basis points; from 5.15 per cent to 4 per cent.
-Reverse repo now stands at 3.35 per cent, a reduction of 155 basis points from 4.9 per cent in March. At 3.35 per cent, the rate is nudging the all-time low of 3.25 per cent seen in April 2009, following the global financial crisis.
-Headline inflation is expected to fall below the target, i.e., 4 per cent in Q3 and Q4 of 2020-21.
-GDP growth in 2020-21 is estimated to remain in the negative territory, with some pick-up in growth impulses from the second half of 2020-21 onwards.
-Monetary policy transmission to banks’ lending rates has continued to improve. The one-year median marginal cost of funds-based lending rate (MCLR) declined by 90 bps between February 2019 and May 15, 2020.
-The weighted average lending rate (WALR) on fresh rupee loans has cumulatively declined by 114 bps since February 2019, of which 43 bps decline occurred in March 2020 alone.
-The loan moratorium was extended by another three months, till August 31, 2020 and the interest for the six months from March to August can be converted to a funded interest term loan (FITL) payable by March 31, 2021.
Some of the issues in / expectations of the market that are not yet addressed are:
-TLTRO 2.0 has not taken off; it has been utilized only to the extent of Rs 12,850 crore, out of notified amount of Rs 50,000 crore. Banks being apprehensive about the credit quality of potential NBFC exposures is the main reason. The announcement of the SPV for Government guarantee of Rs 30,000 crore and Partial Credit Guarantee of Rs 45,000 crore are good gestures, but the tenure of three months is too short.
-There was an expectation of the one-time restructuring of loans. Granting another three months and allowing FITL is a good move, but the stressed market was expecting more.
-In view of the huge Central Government borrowing of Rs 12 trillion, plus potential slippage, along with State Government borrowing as well as PSU borrowing, some OMO announcement to support the market was also missing.
Where do we stand now? The Government and RBI have taken a calibrated approach on announcements rather than exhausting all ammunition in one go. As and when the borrowing program proceeds over the course of the year, we expect support from the RBI. The last stop is monetization, i.e., direct purchase of Government bonds by the RBI.
Takeaways for fixed-income investors
In normal times, when the central bank cuts rates and commits to an accommodative stance, it is time to go long on bonds/bond funds. It means, buying long maturity bond funds so that by virtue of the longer portfolio maturity and longer portfolio duration, gains in the portfolio as and when yields come down (i.e. bond prices move up) will be proportionately higher than a short portfolio maturity fund. However, the present times are unusual.
The huge borrowing would keep yield levels under upward pressure, but will be supported by the RBI. Hence, longer maturity G-Sec funds or corporate bond funds may not be the best choice for the next few months. In this context of long maturity, the ballpark is 10 years or so and the rough tenure for short portfolio maturity is around three years. However, investors can look at G-Sec funds for a long investment horizon, say five or 10 years, as there is no credit risk in a G-Sec fund, and the potential volatility will even out over a long horizon. For a horizon of, say, 1-3 years, it is preferable to opt for a short portfolio maturity so that volatility would be lower. In the current context of tight bond market for papers rated less than AAA and the weak economy pointing to potential defaults, credit quality of the portfolio is of paramount importance.