The Hindu Business Line : What the CRR cut means for investors

As a result of the CRR reduction, a huge volume of money would be released into the banking system, which will ease liquidity and bring support to the debt market. Hence we may see short-term rates easing up.

Ramanathan K

The RBI’s recent move to cut the cash reserve ratio by 150 basis points was welcomed by many participants in the debt market as it is expected to infuse much wanted liquidity to the extent of Rs 60,000 crore into the banking system.

How would the CRR cut change the outlook for debt instruments? How should investors react to this move? The following Q&A throws some light on the above issues:

What is CRR and what does the present CRR cut seek to achieve?

Cash reserve ratio (CRR) is the amount of funds banks have to keep with the Reserve Bank of India. If the RBI decides to increase this ratio, the available amount with the banks comes down.

In other words, the RBI would use this strategy (increase of CRR rate), to drain out the excessive money from the banks. On October 8 the RBI decided to reduce the CRR with effect from the fortnight beginning October 11, 2008.

As a result of this reduction in the CRR, huge money would be released into the banking system, which will ease liquidity and bring support to the debt market. Hence we may see short-term rates easing up.

What does this mean for the money market?

With the cut in CRR, we may see money market and short-term rates easing.

What does it mean for Institutions, retail and HNIs?

Our view on the fixed income market will continue to remain positive in the medium to long term. Investors may allocate a higher share of their fixed income assets into long-term instruments.

What does this mean for the FMPs you already hold?

Fixed Maturity Plans are typically held-till-maturity schemes and there is minimal interest rate risk in such schemes.

What does this mean for bank fixed deposits?

As we have seen peaking of short-term rates and since the RBI has gone into a neutral stance, we can see easing of short-term interest rates within the next three months.

What opportunity does this bring for me?

Investors should invest in long-term funds to capture the positive interest rate environment.

What kind of returns should I expect from debt over a six, nine and 12-month investment horizon?

With a 6-9 months investment horizon, investors can expect returns of 200 basis points over the liquid fund returns; those with a 12-month investment horizon can expect to earn 400 basis points over liquid fund returns.

What does this mean for real estate companies in the market?

This CRR cut will bring back the liquidity in the banking system and ease up the cash availability for corporates.

How would my investment in a one-year fixed maturity plan compare with an investment in a bond fund with a similar holding period?

Fixed maturity plans are typically held-to-maturity schemes wherein you lock your assets at particular interest rates.

Hence, there is minimal interest rate risk in such kind of schemes.

On the other hand, income funds have a diversified portfolio of government securities and public sector corporate bonds (largely).

Hence, it would primarily be an interest rate and duration call, wherein the investor can benefit in a declining interest rate scenario.

(The author is Head, Fixed Income and Structured Products, ING Investment Management (IIM), India.)

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