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THE growth-oriented Credit Policy was more or less along expected lines and is a reiteration of the last year's policy. As expected, the RBI left the key rates unchanged and has struck a cautious note on inflation in light of the global crude oil prices and increased money supply in the system. The Governor has also highlighted the interest rate risk exposure of the banking sector. Overall, the policy has re-emphasised the strong economic fundamentals and the need to deliver credit efficiently at lower rates to various sectors. The 10-year yields moved to 5.25 per cent on the cautious remarks about inflation, before bouncing back to close at 5.18 per cent as investors cheered the "status quo" bias and comments by the central bank that the soft rate bias would continue. In the corporate bond segment, the yield on the 5-year AAA rated corporate debenture benchmark was at 5.82 per cent and the corporate spread over gilts was at 90 bps.

What is Franklin Templeton's view on the Policy?

We believe that RBI has taken a much softer stance than expected due to the fall in the stock markets in recent times and the fact that there is no government in place. The policy indicates that the RBI is comfortable with the current interest rate environment and rate movement will be dependent on domestic factors rather than developments in other countries. It will continue to focus on improving credit delivery mechanisms to ensure that the benefits of a low interest rate regime reach smaller corporates and the SSIs.

The central banks comments on the high level of sovereign bonds holdings by banks and poor credit pick up appears to be a signal for the banks to start lending more instead of investing in gilts, in order to improve credit delivery and reduce the interest rate risk exposure of the banking sector.

The RBI has indicated that it will provide adequate liquidity to meet credit growth and support investment demand in the economy while continuing a vigil on movements in the price level.

Where are the debt market headed?

The markets are expected to remain range bound with no major movement on either side, given that liquidity is expected to remain easy. (10 year yields to move in the range of 5.15-5.25 per cent in the immediate term) barring any negative developments.

There were no specific measures in the credit policy that curb liquidity. While liquidity continues to remain comfortable and RBI has maintained its soft rate bias, any negative developments like political instability and rise in global crude oil prices and yields could impact sentiment.

We expect yield curve to steepen at the long end gradually and corporate G-sec spreads may not contract sharply from these levels. Yields at the short-end of the curve will remain easy due to the excess liquidity. Last year it was the liquidity, which drove interest rates, this year it appears that it will be fundamentals (read inflation) that will be prime driver of interest rates.

What should investors expect?

Investors with a long-term view have nothing to worry about, as their exposure to income and long-term gilt funds should deliver returns in line with expectations over their investment horizon.

While the short term performance of schemes like liquid, short-term gilt and income may vary depending on market conditions, our view is that investors should stay invested and adopt a disciplined stance for realising their investment goals. Investors could consider floating rate funds to reduce volatility on the fixed income portfolio and hybrid funds like MIPs, based on their risk profile.

Market view by Franklin Templeton Mutual Fund

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