2 weeks Ago
The Reserve Bank of India’s (RBI) decision to reduce the cash reserve ratio (CRR) in its bi-monthly monetary policy marks an important first step in its policy easing cycle. While narrowly seen as a liquidity measure, injecting close to 1.16 trillion in primary liquidity, the CRR cut carries broader implications.
Unlike open market operations (OMOs) or forex intervention-led liquidity infusions, a CRR cut directly reduces the cost of funding for the banking system and facilitates better transmission of the anticipated rate-cut cycle. Although some market participants expected a simultaneous repo rate cut, particularly in light of the weaker-than-expected second quarter GDP print, the significance of this move should not be underestimated. The is likely to follow up on the CRR cut with a series of repo rate reductions starting February, provided there are no significant macroeconomic or geopolitical disruptions.
Additional liquidity measures, such as open market bond purchases, are also anticipated in the coming quarters. The domestic macroeconomic landscape has evolved to support this easing cycle, driven by significant improvements in twin deficits (fiscal and current account), stable and low core inflation, an anticipated decline in headline inflation (projected by the RBI at 4% for Q2 FY26), and softening growth trends. Impact on debt markets Debt markets have already begun pricing in the expected easing measures.
Longer-maturity government securities (G-Secs) and corporate bonds have reacted positively over the last 18 months, while short- and intermediate-maturity securities have started aligning over the past three to six months. Short- and intermediate-maturity instruments are influenced by both the direction and timing of monetary policy actions. The recent moves in these securities indicate market expectations of an imminent easing cycle, with the CRR cut serving as its precursor.
From a pricing perspective, short- to medium-term securities are particularly attractive, offering competitive yields and favourable spreads of corporate bonds over G-Secs. Longer-maturity bonds also hold potential for significant price appreciation, even with smaller yield movements, due to their higher duration profiles. Portfolio strategy With a 12-month investment horizon, a balanced, risk-adjusted allocation in the debt markets could favour an overweight position in intermediate-maturity debt securities.
This includes portfolios comprising 3–5-year corporate bonds and 5–10-year G-Secs, with a suggested allocation of 60–70% to these instruments and 30–40% to longer-maturity securities on the yield curve. For intermediate-duration corporate bonds, the choice between high-grade corporate debt papers and high-yield instruments should align with the investor’s risk appetite. Assuming stable conditions, the health and balance sheets of Indian corporates, including financial services entities, remain robust and capable of weathering short-term business cycle pressures.
From a structural perspective, for investors with long-term horizons, India's steadily improving macroeconomic backdrop, an inflation-focused central bank, and a fiscally disciplined government suggest a continued secular decline in interest rates over the next 5–10 years. In such an environment, reinvestment risk poses the greatest challenge for those relying on short-maturity debt instruments. Consequently, maintaining an allocation to longer-maturity G-Secs and corporate bonds should be a core component of any long-term debt portfolio.
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