Oct 22, 2001|
Rate cuts: Short term impact on bond funds
The RBI has announced a reduction in bank rate by 50 basis points to 6.5% and 200 basis points cut in CRR to 5.5%. This is expected to push bond yields lower, as bond prices perk up.
The rate cuts will benefit existing investors in income funds. With the rise in bond prices, the fund portfolio will appreciate pushing up the net asset values (NAVs). However, the appreciation in bond prices will not sustain beyond a point and prices will settle at a level lower than the current one.
Existing income fund investors will witness a surge in their fund performances. However, the impact will be short term in nature and investors need not get too overly optimistic with the appreciation. Bond prices had already factored in this move (but not the magnitude, the 2% CRR cut was very surprising) and consequently after the announcement prices appreciated only marginally.
In the Budget, the finance minister and the RBI signaled a willingness to move towards a lower interest regime. This is the second chapter of that move. As we move towards a lower interest paradigm, there will be an overall decline in interest rates, which will ultimately push bond coupon rates lower. Income fund investors will then witness lower growth on their investments and this will continue as long as the RBI pursues the cheap money policy.
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