Credit Policy – Fixed Income implications
RBI surprised the market with its hawkish stance, in its recent credit policy. This was despite the fact that earlier on, the Govt. decided to walk the path of Fiscal prudence in the annual budget. Not only did it not lower rates but also changed its stance from accommodative to Neutral. We do note that there is some amount of inflationary pressure arising out of the rising global commodity prices.
However, the combination of tight monetary & fiscal policy on the one hand and an economy operating at sub potential on the other, quite clearly sets the stage, where inflation & inflationary expectation will be squeezed out of the system. As expected level of inflation in future comes down, bond yields will come down and Bond prices for the longer duration bonds will go up. As such the recent bond sell off should be used for increasing duration. (That is buy mutual funds invested in longer duration Govt/Corporate bonds).
Such investments are likely to generate over 8 to 9% annualized returns. However various global factors such as lower taxes & more infrastructure spending in USA, reduced bond buying by European Central Bank etc., may lead to further hardening of global bond yields. In such an eventuality, we may need to review our bullish stance on longer duration Fixed Income papers in India in the months ahead.