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All the debt funds took a big hit on 16th July 2013 on the account of RBI’s action to curb the volatility of the Rupee

Before we begin let us clear some definitions :-

Repo Rate : Usually the banks can borrow from RBI for overnight at Repo Rate which currently is at 7.25%. Till now there was no limit to these borrowing put by RBI.

MSF (Marginal Standing Facility) Rate : In laymens term it is very much similar to repo but used incase of extremely desperate borrowing to meet out there liquidity requirement. This is usually 100 basis points higher than repo. (However, it has been raised by 200 basis points more by RBI recently).

LAF (Liquidity Adjustment Facility) : The amount of borrowing a bank can do on the grounds of Repo.

RBI Action

RBI announced a series of measures late at around 10 PM on 15th July 2013 to control the volatility of the Indian Rupee. Measures taken were as follows :-

  1. Borrowing by the banks under LAF was restricted to Rs 75000 Cr
  2. MSF rate was increased by 200 basis points
  3. RBI decided to carry out open market sale of bonds.

The repo based borrowing was restricted to Rs 75000 Cr, thus the banks needing more funding to meet their liquidity requirement will have to go through the MSF route.

By hiking the MSF rate, RBI is tightening the liquidity in the system. This has resulted in the rise in the short end of the yield curve by around 200-250 basis points and long end of the curve by 50-100 basis points.

This has resulted in the increase in yields and thereby decrease in the bond value across debt category.

Category Avg Return (%)
Gilt Medium & Long Term -2.59
Income -2.03
Short Term -1.39
FMP -0.92
Others -0.77
Gilt Short Term -0.71
Ultra Short Term -0.47
Liquid -0.18
Overall -1.02
Outcome

These measures were taken from the view of stabilizing the volatility in the Indian Rupee, however not much impact has been made so far. The currency market reacted barely with 50 to 70 paise appreciation in Indian Rupee.

Some volatility in Gsec will be seen for a month atleast, till some clarity from the currency angle comes.

This incremental cost of funding by 200 basis, has increased the yields of the short end of the curve and thus short end of the curve can give some good investment opportunity.

According to the Chief Economic Advisor of India, this is a temporary step taken by the RBI to curtail the Rupee fall. However, he did not define the time for this temporary step.

Even I am of the view that this is a short term measure. If RBI had raised CRR/Repo then it would have been permanent in nature. I believe this will not change RBI’s monetary stance. With CAD coming down, IIP going to negative level and RBI balancing between Growth-Inflation dynamics, there is very less chance of a rate hike. RBI may keep the rates at the same level or decrease them, but there is very little probability to increase them.

My View

You should look at the current situation as a distress sale. The yield curve is at June 2012 levels. Next few weeks will remain quite volatile, however these are a very good time to enter the debt market.

The short end of the curve has become very attractive for new investors. If you have money for 1 year, then this is a very good time to enter.

This is also a very good time to enter into good banking stocks. I feel the markets have over-reacted and have beaten down the banks by a good level. This is a great opportunity to enter into good banking stocks.