Will a CRR hike spoil the debt mutual fund party?

The Reserve Bank of India (RBI) has temporarily sucked out excess liquidity from the banking system via an incremental CRR hike of 100 per cent last week. Now, some market participants are speculating whether the banking regulator would hike CRR from the current 4 per cent. Some others are also of the opinion that the central bank may offer market stabilisation bonds. In short, ample liquidity in the system may not last longer. How will it impact debt mutual funds?

“This is a temporary measure and won’t affect debt mutual fund investors with a long term perspective,” says Lakshmi Iyer, CIO-Fixed Income, Kotak Mahindra AMC.

Cash Reserve Ratio (CRR) is the percentage of total deposits that banks have to mandatorily keep with the RBI. The RBI doesn’t pay any interest on it.


“Incremental CRR hike is a temporary measure and will be hopefully reversed once the MSS (Market Stabilisation Bonds) come in market,” says Murthy Nagarajan, Head-Fixed Income, Quantum Mutual fund. The RBI will decide on the incremental CRR hike on or before December 9, after reviewing the liquidity situation in the banking system.


Will RBI hike CRR?
“Besides hiking CRR, RBI has many options to manage liquidity. It has already started conducting reverse repo of longer tenure; it can introduce Market Stabilisation Bonds and can conduct open market sales of securities,” says Iyer.

Nagarajan feels that most of the money which is creating the surplus in the system will flush out over a period of time and there is no need for the RBI to hike the CRR. He further adds that the objective is to cut down the lending rates; if the CRR is hiked, banks won’t be able to reduce the lending rates as their profits will be significantly affected.

A CRR hike would push up interest rates and that is bad news for debt mutual funds, especially long-term gilt and income funds. Interest rates and bond prices travel in opposite direction, and when the rates go up, the prices of bonds fall. “A hike in CRR will affect debt mutual funds in an extremely bad manner,” says Nagarajan.

“If CRR is hiked, it will definitely have some sentimental impact in the market, but only for a limited time,” says Iyer.

What should investors do?
“Fundamentally we are convinced that the rates in India have to ease in a gradual manner and as long as that intent is there and no significant data is there to prove a hike in the rates, the investors should remain invested and not panic during short term volatility,” says Iyer. “They should also invest more with a long term perspective and take advantage of the opportunity, if there is any,” she adds.

“Dynamic bond funds would be the safest bet for debt mutual fund investors if there is an increase in the CRR,” adds Nagarajan.

Lastly, always pick a debt mutual fund based on your investment horizon. Resist the temptation to cash in on the interest rate movement by betting on funds that do not match your investment horizon.