Should investors consider liquid funds or target maturity funds when rates rise?
Sunil Subramaniam: We tend to look at the RBI thing from a narrow perspective of inflation versus growth. But it’s important to keep in mind that RBI wears three hats. There is a monetary policy hat, there is an interest rate hat which I differentiate slightly from the liquidity aspect, and then there is a currency management hat. On top of all that, there’s the fact that they’re the manager of the government’s debt book. So they have several things to do.
The second thing is that we tend to equate RBI policy with US Fed policy. RBI as the central banker and the Fed as the central banker. We tend to think that the actions of the Fed should be emulated by the RBI and we tend to carry the same objective.
But there are two key differences. The first difference is that advanced countries are demand-driven economies where rates and liquidity flow directly to the retail consumer and directly cause or reduce inflation, whereas India is a supply-driven economy . In a supply-driven economy, interest rate policy has a limited role to play because supply can affect interest rates on corporate borrowing, but not so much by the consumer on the ground, because either way demand is not the key.
Thus, the ability of interest rate policy to influence GDP and inflation is one. The second thing is the amount of inflation imported into a country like India, which again is not within the purview of an RBI policy. No political interaction or intervention can do anything about importing oil, importing food and the third and most important thing here is that the Fed doesn’t care about currency. Thus, RBI must keep an eye on the management of volatility in the country. They do not target an exchange rate that manages volatility.
So if you look at it in the context of what the RBI did today, it was very good policy, very pragmatic in the sense that they know that frontloading 50 basis points of the upside – c It’s actually up 90 basis points if you take between the last policy and this. So frontloading is basically giving them the chance to boost growth when the supply slackens. That’s why they pre-feed and (don’t) react. The reason the Fed is hesitant to preload is that frontloading directly affects demand growth, whereas in India it does not. So there is no downside to frontloading. It’s only a sentimental thing. It’s a visual thing that I’m planning a hike.
But at ground level, if home loan rates rise 1% – from the 6.5% average they were before those hikes – to 7.5%. What is the impact on EMI for a customer? It’s probably Rs 100-200 per month on a 25-30 year loan. Thus, the RBI policy has more of a signaling effect, rather than an actual reality, ground level effect.
And signaling early frontloading, and maybe another 40-50 basis point hike as well because they were forecasting inflation at 6.7%, which is way above their thing, but they let a small window for the last quarter of the year where they showed it to come below 6%.
So there’s a hint in the policy that if the monsoon is normal and we see food inflation – which is 45% of our CPI basket – go down, then RBI retains the desire to hold rates there or can even to cut rates to support growth in the last quarter of the year. It is hidden in the tongue. But the way I see it is that’s why he broke four quarters.
For me, it is very pragmatic in a country like India to preload because the Fed preloads; it hurts where it hurts most, hitting almost below the belt because consumers are directly affected.
So, RBI laid off on the liquidity front. They talked about reducing accommodation over a period of years. So, liquidity is also something that RBI avoided in strong action today.