The Hindu Business Line : Cautious stance

The central bank has adopted a cautious tone and is looking to strike a balance between containing inflation and maintaining economic growth. Since its last policy review, headline inflation numbers (WPI) have surged over 7 per cent and this has become a political issue ahead of elections. The Government has announced various fiscal measures, including reduction in import duties and export bans in various sectors.

Growth expectations

The GDP projections have come in at a higher-than-expected level and are probably reflecting expected growth in the services and agriculture sectors.

The services sector, in particular, is not capital intensive and this could explain the lowering of credit growth projection. The higher 5.5 per cent inflation growth is an indication that RBI expects higher economic growth to keep prices at a relatively higher level. The 25 bps hike in CRR, following the recent 50 bps hike, reflects the central bank’s efforts to reduce systemic liquidity and, thereby, anchor inflationary expectations. The latest hike will take out around Rs 9,000 crore from the system and pegs the CRR at a seven-year high.

Global rate movements

Global interest rate direction remains mixed with rates moving down in the US, Canada and the UK, but central banks in Europe and Japan have been on hold. Asian economies have been witnessing monetary tightening, especially in China.

Central banks have been injecting liquidity to prop up credit markets and avoid systemic failures. Commodity and oil prices remain the key factor at this juncture. The RBI is also looking to provide Indian companies with hedges against the rise in global prices by allowing them to invest in natural resources companies overseas and allowing domestic oil companies to hedge.

Market direction

While key interest rates have been left unchanged, we expect the upside to be limited over the near term, as market direction would depend on inflation and liquidity fronts. The rally in gilts could be short-lived given the supply situation — MSS bonds and the fact that government borrowings are front-loaded in the first half of this fiscal year. The movement of the short end of the curve will depend on the liquidity levels once all the CRR hikes come into effect. Corporate spreads are likely to be range bound.

We are not looking to alter our portfolio strategy, given the various imponderables. We will continue to maintain a medium duration in our various portfolios and also take advantage of any sweet spots on the yield curve. Investors should look to focus on funds such as Short-term Floating Rate Funds, FMP and Ultra Short Bond Funds.

(The author is Chief Investment Officer, Fixed Income, Franklin Templeton Investments.)