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It’s a new year and a new month—a lot of things might have changed for you but the RBI’s status quo hasn’t! The point to note is that the inflation rate for fiscal year 2024 is thought to be high due to concerns about inflation in food prices. The RBI is still hoping to keep inflation at 4%, though. While that being said, the chances of rate cuts are improbable but can remain unchanged or increase; as you know, their relationship is quite inverse. But surely, towards the end of the fiscal year in Q4, the rate cuts might show up.
Let’s learn about the RBI’s actions and things associated with the situation, as well as the impact of the unchanged policy interest rate on your investments in bonds. Also, let’s unfold what to expect in the near future.
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The Basic Story of How Things Work
The central bank of India is none other than the Reserve Bank of India, which is popularly known by the name RBI. While this entity is in the nation, they have a set of responsibilities to take care of, among which are the repo rate and inflation.
There is a Monetary Policy Committee under the RBI that takes care of controlling the benchmark policy rate, also known as the repo rate, which is a monetary tool used to control growth and inflation.
India’s growth is definitely a big deal for the economy and to run that smoothly, inflation needs to be under control, not just because there are many other things involved. For now, let’s focus on this situation alone.
In maintaining the demand and supply of money in the economy; the need to create liquidity and reduce liquidity in the economy matters the most. So a repo rate is an interest rate that the RBI decides to lend money to commercial banks when there is a shortage of money with the commercial banks. On the other end, inflation, as you are aware, means that the prices of goods will usually be higher than normal. It is important to control inflation and ensure that the repo rate is increased or decreased.
The repo rate and inflation have an inverse relationship with each other. In order for the RBI to control inflation, the repo rate is usually increased; by doing so, it’ll be more expensive for the banks to borrow money. That way, the flow of money in the economy is lower, and the demand for it is lowered too. Which in turn aids in keeping prices stable, not making India too expensive to live in.
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About the Current RBI’s Action
For the sixth time, the repo rate hasn’t been changed, so the MPC’s current goal is to completely pass the policy transmission of the previous rate hike of 250 basis points since May 2022 on to depositors and borrowers, which has remained partially incomplete so far and also to keep the inflation target at 4%.
The RBI’s mission is clear, which we understand right now. The RBI usually has certain policy actions it wants to take and they are transmitted through a process called policy transmission. These actions are nothing but the actions that it wants to take to infuse growth in the economy.
When the RBI decides to increase or cut the repo rates, the banks must incorporate this into their system. But most often, in India, 50% of the time it hasn’t come into force. This gets completely into action in two stages: the first stage is where the shock of the policy change reaction will affect the various financial segments, and the second is where it is implemented in real.
So full policy transmission means it wants to enforce that hike in real-time, which is only followed by depositors but not the loan sector, which is what the policy transmission thing is referred to here. The RBI has also mentioned that there will be a withdrawal of accommodation, which means that it wants to reduce the money supply in the market by increasing the interest rate.
As of December 2023, the CPI inflation rate was 5.69%. And expects to control it to 4% by this fiscal year, as this is one of their concerns. Currently, the repo rate is unchanged at 6.5%. So until the government brings inflation to 4%, rate cuts are improbable.
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The Impact of Repo Rate on the Bond Investments
When the repo rate hikes, so will the bond yield. But in the bond market, when the interest rate increases, the bond price decreases, so with an increase in the repo rate, the bond prices will decrease. For an investor, the bond with the existing interest rates looks less attractive but the hiked interest rate looks more appealing to sell in the secondary market.
When the repo rate has a cut, the bond yield drops too, and hence there is an increase in the price of the bond. For an investor, the existing bonds they own are more appealing than new issuances, as the new bonds that will come on the market will be sold at a higher price and at lower interest rates compared to the existing ones.
When it is unchanged, it just means the investors will have whatever they have.
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What to Expect Further?
By assessing the current situation in the economy, the current inflation rate is at 5.1% as of January 2024, when compared to December 2023. So the inflation is slowing down, which means we can’t expect rate hikes any sooner but in the final quarter of 2024.
Investors at this point can invest in long-term bonds to benefit from the current interest rates before the rate cuts. In order to manage the liquidity in the market, short-term bonds might look more appealing to investors, such as a 1-year bond that gives a greater yield than a savings account, which can be considered to fulfill short-term goals.
The Wrap
Keeping a tab on market conditions is as important as keeping an eye on your financial goals, as these factors allow you to plan accordingly to achieve the goal you might have. While that’s about the current situation of the market and the decision of the RBI towards it, what will be your next move, or how have you been placed in your investment journey so far?
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