2014 maintains status quo on interest rates

 

The year 2014 was characterised by falling prices of oil and gold, leading to a reduction in inflation. However, India maintained its status quo on interest rates.
The key benchmark rates i.e. the repo rate, reverse repo rate and the Cash Reserve Ratio (CRR) were maintained at the levels of 8%, 7% and 4%, respectively.

 

 

These rates last saw a revision in October 2013 when the new Reserve Bank of India (RBI) governor Raghuram Rajan increased the rates by 50 basis points.

Although the level of inflation (as measured by the CPI) halved during the year-from 10% in January 2014 to 4.38% in November 2014-Rajan was still not in the mood to cut interest rates in his fifth bi-monthly monetary policy in December 2014.
He has, instead, adopted a wait-and-watch approach to ensure that inflation doesn't start moving up again since food inflation has been consistently high.
Food inflation has been hovering at 10% in the last five years.
Having said that, due to the yield attractiveness, Indian bonds are trading at 8% compared to 2.4% in the US, thereby attracting record inflows of $25 billion from Foreign Institutional Investors (FIIs) in 2014.
FULL COVERAGE: Newsmakers in 2014

This is likely to cross $30 billion by the end of the calendar year.
In spite of no change in interest rate movements, the benchmark 10-year bond yield has fallen from a high of 8.9% in January 2014 to 7.9% in December 2014, owing to lower inflation, falling crude oil prices, fall in vegetable prices and an imminent rate cut expectation.
In fact, this has led to debt mutual funds delivering double-digit returns for the year.
The longer tenure bond and gilt funds have significantly outperformed the shorter tenure ones.
The income fund category, for instance, has returned 13% in the last one year while gilt funds have returned 17% on an average compared to 11% return delivered by short-term debt funds and 9.5% returns of short-term gilt funds.
Falling interest rates and yields are good news for bond investors as interest rates and bond prices share an inverse relationship, hence any fall in rate and yield will lead to an appreciation in bond prices hence the NAVs of bond funds and vice a versa.
Inflation is expected to hover in the band of 5% to 6% levels in the next calendar year compared with 8% levels in 2014, which would easily meet RBI's target of 6% for March 2015.
Based on these hopes, the market can look for 50-100 basis cut in policy rates by the RBI.
This can also result in bond yields moving down by another 50 basis points in 2015, with the ten-year bonds expect to trade in the band of 7.25 %-7.50 % levels by the end of 2015 from 8% ten year rates prevailing in the markets.
Following the cues, lending and deposit rates have too started to soften by about 10bps-20bps.
However, there has been no significant change considering credit growth has been rather slow, increasing only 10% in the year to November 2014, the lowest since 2009.