The Hindu Business Line : Market View

The RBI's monetary policy continues to be shaped by a combination of global and domestic factors — global cues on interest rates, inflation and oil prices with their implications for trade or capital flows into India and domestic inflation. Since June, the US Fed had raised rates by 25 basis points to 5.25 per cent, China has raised reserve requirements for its banks and Japan has hiked its rates to 0.25 per cent ending it's zero-rate policy.

Domestic inflation numbers are hovering close to the five per cent mark, even with only a partial pass-through of higher oil prices, and the Indian crude oil basket has recently crossed the psychological $70 mark.

Given this background, the domestic debt markets had mostly factored in a 25 basis-point hike in repo or reverse repo rates in the run-up to the quarterly review. The move appears to be a pre-emptive measure against possible inflationary pressures and the central bank would have derived comfort from the fact that rate increases in the last year or so have not adversely impacted GDP growth.

The immediate market response to the rate hike has been muted, with yields on the benchmark 10-year gilt edging up to 8.26 per cent (close: 8.21 per cent) at the time of writing this report. However, the policy statements with respect to money supply and credit have cautioned on the faster-than-expected growth, which suggests a negative bias to the interest rate policy over the next few months.

Credit growth numbers, after adjusting for the base effect caused by differing reporting periods, are at 32.9 per cent over the first quarter, according to the RBI. These appear quite high and well above the bank's full-year target of 20 per cent, suggesting continued high off take of corporate credit.

Given the increasing pressure on the cost of funds for banks in recent times, further upward pressure on lending rates to corporates and thus on corporate bonds, cannot be ruled out. However, liquidity continues to be easy as reflected in the LAF (Liquidity Adjustment Facility) amounts.

Under the circumstances, we see the slope on the yield curve continuing to be steep over the next few months. Given that the rate increase was mostly factored in at the short end of the curve, we will continue to retain relatively higher exposure to short term bonds of one-year tenor.

Franklin Templeton Investments

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