Medium-to-long term debt segment looks attractive

Feb 09, 2023

A majority (4 out of 6) of members on RBI’s Monetary Policy Committee voted in favor of both, an increase in the repo rate by 25 bps to 6.5% and retaining the focus on withdrawal of accommodation to ensure that inflation remains within the target going forward.

Dr. Ashima Goyal and Prof. Jayanth R. Verma voted against the repo rate increase and the stance.

The standing deposit facility rate now stands at 6.25% while the MSF and bank rates stand increased to 6.75%.

Our Views

While the majority of market participants expected a 25 bps rate increase, there was a view in some quarters that the RBI would change to a neutral stance from a withdrawal of accommodation.

In the debt market while the benchmark 10 year G-Sec yield was trading flat before the announcement, it moved up by 3 bps post-announcement to 7.34%.

The RBI expects solid growth of 6.4% for the economy in FY23-24 led by 7.8% growth in the first quarter of FY23-24, which may be optimistic given the global growth headwinds that are likely in the short term.

Inflation is expected to recede to a 5% level in the first quarter of FY23-24 before increasing to a 5.6% rate by the end of the financial year. The RBI’s full year inflation forecast is at 5.3% a decrease from an expected 6.5% in FY22-23 on a moderation in price pressures. The MPC also expressed concern on the sticky Core CPI levels (6.1% in December) driven by price pressures in health, education and personal care and the need to bring it down. The continued focus on keeping inflation in check should bode well for the medium term monetary policy outlook for the country.

In terms of high frequency indicators, PMI releases for both the manufacturing and service sectors remain solid for the month of January. While the manufacturing PMI came in at a reading of 55.4 signalling continued strong expansion, the services PMI for the period was reported at 57.2.

However both readings are down from the December level reading indicating some moderation in activity. Notably, the indicator for international sales growth has fallen to a 10 month low during January.

Going forward, high contact services sectors should continue to remain strong given upward momentum from the depressed economic activity due to the pandemic in 2020 and 2021.

In the post policy press conference, RBI Deputy governor, Dr Michael Patra while noting that real policy rates were now 0.9%, did not comment on where the real policy rates would settle over the medium term. Real policy rates are likely to settle at a level below the pre-pandemic policy rate of 200+ bps given the RBI’s focus on growth over the medium term.

Managed Portfolios Positioning

The surge in short term yields (1year T-bill yields up 240bps) accompanied by a smaller rise in long term yields (10year GSec yield up 90bps) over the past 12 to 15 months on the back of successive rate hikes and withdrawal of liquidity by the RBI has resulted in a flattening of the yield curve.

Based on our valuation implied return (VIRs) forecasts, the medium-to-long term debt segment (5-10 years maturity) looks relatively attractive vs cash and high credit quality short term debt, and we continue to remain overweight in this segment.

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