RBI shocks markets with a 40 bps rate hike. What should debt mutual fund investors do?

The Reserve Bank of India has surprised the market with a 40 basis points (100 basis points = 1%) rate hike in its policy rates. In an unscheduled meeting, the Monetary Policy Committee (MPC) unanimously decided to hike rates for the first time after 2018, while keeping the stance accommodative. RBI also announced a hike of 50 BPs in cash reserve ratio (CRR) to 4.5 per cent, effective May 21.

The decision has taken both the equity and bond market by surprise. Sensex fell around 900 points after the announcement. The government bond market witnessed a sharp selloff ahead of a statement by Reserve Bank of India Governor Shaktikanta Das. The yield on the 10-year benchmark government bond shot up as much as nine basis points to 7.22%.

“It is necessary for monetary policy to focus on withdrawal of accommodation. The decision of the MPC today to raise the policy repo rate by 40 bps to 4.40 per cent may be seen as a reversal of the rate action of May 2020,” Das said. Today’s decision should be seen as a continuation of the announcement that the RBI was focused on withdrawal of accommodation," said the RBI governor Shaktikanta Das.





Debt mutual fund managers believe that the rate hike cycle has just begun and we could see more rate hikes in future. "Finally, RBI has woken up to inflationary expectations and hiked rates by 40 bps to take the effective corridor to 4.15% - 4.65%. Market participants should expect at least a 35 bps hike in June as well. In spite of the hikes, the monetary policy stance still remains accommodative. It is like saying that your salary has been increased, but you still remain underpaid. The implication is the rates need to be hiked far more than current levels. While RBI actions are most welcome from a financial stability perspective, inflation will stay high for months to come. CRR has been hiked as well reducing liquidity in the system. One can expect the US Fed to increase rates and providing guidance on the pace and quantity of reduction in its gargantuan balance sheet. It is likely to be a tough market for all asset markets. Indian bonds could trade later in range of 8-8.50%," said Sandeep Bagla, CEO, Trust Mutual Fund.

Debt mutual fund managers also believe that the RBI move has signaled that this rate cycle is not going to be gradual. "I think even though it was a surprising move, RBI has re-gained the confidence in terms of its fight against inflation. It is a welcome step as far as the pace of policy resetting goes. The bond prices have reacted negatively, which was expected. I believe that floating rate funds can do well in such a situation," says Akhil Mittal, Debt fund manager, Tata Mutual Fund.