Fixed Income: Perils of Selective Tightening May Gradually Emerge…

The two recent events of consequence to fixed income have been the budget and the monetary policy announcement. The budget has announced an additional borrowing of Rs.80,000 Crs for Feb and March, the original borrowing plan was getting over by Jan 21, end. While this additional borrowing is not that much unexpected, that there is more borrowing that is going to come through dampened the markets a little bit and pushed the yields higher. The gross borrowing program for the coming year is placed at Rs.12 Lakh Crs. While this is on the higher side compared to borrowing program for a normal year, we need to make allowance for the fact that this year is just after an extremely distressful one, and the government expenditure cannot be curtailed as there is a need to support the economy when consumption and investment spending are lagging. On the fiscal deficit front, the timeline drawn for achieving fiscal consolidation and for bringing it down to less than 4.50% is 2025. This is considered a long time to set things right but given the demands on the government on account of the pandemic, it looks quite in order.

The monetary policy announcement from the RBI, was an affirmation of the accommodative stance. RBI has committed to supporting the economy and markets through liquidity provision from time to time so that growth becomes sustainable and we are able to preserve and nurture the rebound in economic activity. On inflation front also, the picture that is presented is one of moderate inflation but within the target ranges set by policy. Food inflation is likely to be under control whereas one challenge that may arise could be the price of pulses and also that of crude oil. But the policy was not free from a shade of tightening as the CRR was hiked by 1 %, taking it from 3 % to 4 %, the re-pandemic CRR rate is going to be re-established between March and May this year. This is a measure that will make credit expensive and may have an impact on borrowing and lending rates, and therefore they will exert upward pressure on market rates. Detailed discussion on both the budget and the monetary policy are available in separate notes provided in this publication.

While the benefit of liquidity will continue to be available for the markets, the emerging shades of tightening cannot be ignored. It may be recalled that the RBI had, earlier in January, moved back to the daily variable repo as part of the normalization process. That was the first indication of the central bank gradually moving things back to a normal days’ arrangement. But the message is that there is need for more close tracking of rate movements, and the increase in the pace of normalization which is quite likely in the coming days should be monitored for both existing and fresh investments. Till the time the process of normalization does not come to a close the market rates may gradually inch higher. Therefore, fresh investments may be made only at the very short end of the curve. Wherever, longer end investments are there, the same may be reviewed to ascertain the need for a change in the portfolio against a changing scenario.


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