The monetary policy committee is widely expected to maintain the status quo on policy rates and keep the accommodative stance. The upcoming policy will however be watched for the RBI’s stance on liquidity management. While the RBI may not shock the system with a reverse repo hike—says Madhavi Arora, lead economist, Emkay Global Financial Services—the policy will be used as a lever to prepare markets for a gradualist approach toward normalization through both communication and action.

Fund managers expect the central bank to adopt a slow and steady transition. They believe that the markets will still be assuaged; that no premature tightening of financial conditions will happen and the uptick in yields will be managed. Central bankers across the world are on the cusp of easy money giving way to a normalising process. Indian policymakers are expected to follow the same thought process. " They will have to weigh in data ranging from manufacturing PMI, tax collections, the balance of payments etc which are recovering, to inflation which may continue to surprise on the downside for next few months," says Lakshmi Iyer, CIO (debt) & head products, Kotak Mutual Fund. She adds that the central banker may want to follow zor ka jhatka dheere se, hence make amends to VRRR (Variable Rate Reverse Repo) amount and tenor (increase) and also announce Operation twist (OT) in place of outright bond purchases.

The RBI, on January 8, this year, announced the resumption of variable rate reverse repo auctions to restore normal liquidity management operations in a phased manner.

Pankaj Pathak, fund manager, fixed income, Quantum Mutual Fund expects the RBI to change the forward guidance somewhat to prepare for a reverse repo rate hike by December policy. He says, "Given the core liquidity surplus is persisting close to ₹12 trillion, the RBI may provide a roadmap on liquidity management. The RBI may restrict further liquidity infusion and rely on liquidity neutral instruments to intervene in the bond and forex markets."

This seems in sync with their ‘orderly evolution' of the yield curve narrative.

How will it affect debt mutual fund investors?

Many debt mutual funds had delivered double-digit returns in the last two years. Fund managers see this period as a turning point of the current low-interest-rate cycle. Theoretically, when interest rates fall, prices of fixed income securities rise, leading to an increase in the NAVs of fixed income funds. Thus, you get a positive return from your fixed-income fund investment when interest rates fall and vice-versa. However, fund managers ask bond investors to anchor their return expectations going forward. "The return from bonds would be a lot more normalized over the next year or so as compared to returns delivered in the last two years," says Dhaval Kapadia is Director– Managed Portfolios at Morningstar Investment Adviser India.

Kapadia explains the shorter end of the yield curve could flatten in the near term with further normalization in the banking system liquidity. The Medium-to-long-term segment of the G-sec yield curve is firming up with a rise in crude oil prices and US treasury bond yields. However, the ongoing G-SAPwill provide comfort to market participants and should help absorb heavy G-sec supply. This along with other tools at RBI’s disposal such as OMOs and Operation Twist should provide a buffer to absorb supply pressures, if any, later in the year, thus keeping yields under check.

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