Ye kahan aagaye hum

Even before the advent of Covid, the Indian economy was slowing down. To support growth, the RBI had dropped interest rates and kept banking system liquidity at a good surplus. The fear of the impact of covid on the economy made RBI drop rates another 110bps and increase liquidity to a surplus of almost INR 7 lac crore. With credit demand at a low the excess liquidity pushed down interest rates even below the RBIs benchmark repo rate of 4%. The consensus was that given the long runway for the economy to recover, the rates would remain depressed for a long time to come. The RBI too re-iterated with every policy meeting that the accommodative stance will continue.

The sustainability of this came into doubt after inflation began to creep up in the US and yields began to creep up. India was in any case not convinced about long term rates being low – which is why the 10-year gilt remained elevated throughout while short term rates were pushed down with excess liquidity prevailing. All it took was for the government to announce that they were borrowing an additional INR80,000 crores before April. Bond prices began their downward spiral. Reasons? Inflation in India, inflation in US, higher borrowings by GoI etc. Against all logic, the price movement in the short term and long-term bonds was similar.

Hexagon Yeild Curve

So here we are, with an answer to the question I had put in my last letter – Will the market prevail upon the RBI? It seemed so. The RBI was trying hard to convince the market that there is no need for them to demand higher yields; that inflation is under control; that the economy continues to need support and low rates are needed…and just when the markets reconciled themselves to higher rates in the near future, the RBI announced easier measures in their policy review on April 7th. The buzz phrase is “orderly evolution of the yield curve” which essentially means surplus liquidity withdrawal  will be so gradual and planned that it will not lead to volatility in rates!

Hexagon Nifty

With this clarity, one can more confidently plan for the debt portfolio.

1) Funds that were parked in liquid or arbitrage can begin to move to their destination funds.

2) There will be some volatility going forward, but enduring it will be better than losing on long term returns.

3) There are some parts of the yield curve that offer good yields. We propose to invest in those areas. Our calculations show that the additional yield there more than compensates for any likely capital depreciation due to rising rates.

4) This risk will be compensated by some part of the portfolio invested in arbitrage and / or floater funds.


T. Srikanth Bhagavat

Managing Director & Principal Advisor

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