How will Credit Policy affect you

October 27, 2004 12:30 IST

A hike in the repo rate, status quo on the bank rate and higher projections for inflation were the key points of the Monetary Policy announced by the Reserve Bank of India. In this note, we analyse how this impacts debt fund investors.

The RBI kept a lid on the bank rate at 6.00%, leaving it untouched at that level. However, it did raise short-term interest rates by hiking the repo rate by 25 basis points to 4.75%. It has raised its projection for (the point-to-point) inflation for the year 2004-05 (FY05) to 6.5% as compared to 5.0% projected earlier.

The RBI has stated that the country's GDP is expected to grow between 6.0% and 6.5% in FY05, compared to its earlier estimate of 6.5%-7.0%. Inflation proved to be the biggest stumbling block and the main reason why the

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RBI had to tone down its earlier GDP forecast.

What does this mean to the debt fund investor?
Unfortunately, it does not bode too well for him. Raising of inflation projections and hiking of the repo rate in particular are two distressing signs that there could some volatility in debt markets. Of course, to the extent that this has been factored in by the markets in the run up to the policy, the response will be muted.

What investors need to do now?
We reinforce a view that we have maintained for some time now -- debt fund investors need to consider investing in short term debt funds and floating rate funds.

Short-term paper is less affected by macro economic concerns like inflation, rising interest rates, rise in crude oil prices, etc.

Floating rate paper is linked to a benchmark and has its coupon rate revised at regular intervals, which tends to stem the volatility from price pressure.