Monetary Policy | What should investors do as RBI is set to cut interest rates

Though there is a strong case for an aggressive 50 basis points cut in policy rates, the RBI is likely to take a more measured decision to cut rates by 25 basis points.

Policy rate cuts are on cards. The monetary policy committee (MPC) of the Reserve Bank of India (RBI) has all the reasons to go ahead with a 25 basis point cut in the repo and reverse repo rates, if not 50 basis points.

The muted growth figure for Q4 of the last financial year virtually decided the course of action for the RBI. The growth in the gross domestic product (GDP) moderated to a 21-quarter low in Q4 of the fiscal year 2018-19.  The slowdown is visible in both investment and consumption. What’s more, the stress in rural areas, global uncertainties and the non-banking financial company (NBFC)-led liquidity squeeze can continue to put pressure on the growth momentum in coming quarters.

Furthermore, the inflationary trend is also benign. Food prices continue to remain weak. The recent decline in crude oil prices and rupee appreciation considerably reduces the threat from imported inflation. The consumer inflation is likely to stay well within the comfort zone set by RBI.

Bond yields say it all

The bond market is already factoring a sharp cut in the policy rates going ahead. Within the past few weeks, the yield on the 10-year paper has softened by 60-65 basis points and slipped below the 7 percent mark. This clearly indicates that the policy focus is likely to turn dovish and growth-oriented now.

The National Democratic Alliance 2.0 government would want to reflate the economy through a mix of fiscal and monetary policy measures. Given the shortfall in tax revenue, the fiscal space is limited and a stimulus would have to come through the monetary policy.

Budget and policy priorities

Though there is a strong case for an aggressive 50 basis points cut in policy rates, the RBI is likely to take a more measured decision to cut rates by 25 basis points in the forthcoming policy review meet. The central bank would like to wait for clarity on the policy priorities of the new government and the tone set in the first full Budget of the new government.

Banks all the way

Given the macro set up of improving asset quality, fresh capital infusion in public sector banks, and the declining interest rate environment, boosting treasury incomes, the banking sector is expected to lead the next leg of the rally in the equity market. We prefer large public sector banks.

However, more aggressive investors can also start exploring value in the NBFC space. Though the business conditions for NBFCs remain tough, valuations are down to reasonable levels now. Moreover, the declining interest rate environment would also be supportive of NBFCs. But one needs to be quite careful and selective in the NBFC space.

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