India’s delayed rate cut cycle: Mirae Asset's Kruti Chheta explains why RBI’s cautious stance matters for markets

The Reserve Bank of India (RBI) manages monetary policy to control inflation and support economic growth. Interest rate adjustments are a key tool in this process. In an interview with Fortune India, Kruti Chheta, Fund Manager - Fixed Income, at Mirae Asset, explains India's delayed rate cut cycle, anticipating a 75bps reduction to 5.75%. She highlights the impact of global uncertainties, like tariff wars, on domestic policy. Cheta suggests strategic portfolio positioning in the mid-to-long yield curve and long-end bonds to capitalize on rate cuts, emphasizing asset allocation for navigating market volatility.

Edited Excerpts:

Q: India has entered the rate-cut cycle after 5 years. What is the terminal policy rate that you foresee once the rate cycle is over?

A: The rate cycle for any economy is typically driven by its monetary policy, fiscal state and domestic and global economic conditions. While domestic factors mainly drive the decision, global developments can occasionally take precedence.  So far, India has stood apart as it began its rate cut cycle much later than other global central banks, prioritising inflation control and thus delaying the rate cut cycle.

While domestic inflation moderated on expected lines, international developments, particularly lingering geopolitical tensions and concerns around the tariff war, shifted attention towards the global economic narrative.  Nevertheless, current domestic factors - a) moderating inflation (at the lower end of the 4.2-4.5% target range), b) credit and economic growth slowdown and c) evolving liquidity conditions, make a strong case for a rate cut. Considering, both domestic and global factors, we anticipate a cumulative rate cut can be ~75bps in the current cycle to 5.75% from the current 6.25%, with one more rate cut delivered in April and another in the second half of the year.

Q: How have you adjusted your investments/allocation following the RBI's rate cut?

A: Markets often anticipate the decisions in advance, so the real action typically happens well before the actual announcement. To capitalise on this, we too positioned our portfolio early, maintaining a bullish stance on the mid part of the yield curve (3-5Y) and the extreme long end to maximise the risk-reward potential of the current rate cut cycle.

Q: 10-year Bond yields have risen slightly following the rate cut. How do you read the move? Do you see more volatility in the yields?

A: As mentioned above, markets tend to react before the actual action occurs. The recent rate cut was well anticipated, leading to a slight sell-off once it was delivered. In addition to this expected move, tariff-related announcements have introduced some near-term uncertainty. The potential for imported inflation or currency market volatility, which could prompt FII selling, is likely to keep the markets volatile in the near term.

Q: There is a lot of uncertainty on the economic front due to Donald Trump's decisions in the last month. Should debt fund investors be worried about this? How can they be better prepared for any adverse impact?

A: The US election and its outcome have brought along a lot of uncertainty in global markets, pushing the economies to adopt a “nation first” policy. While most announcements so far have been used for negotiations rather than actual disruptions, volatility persists, with fear that tariffs could cost 30–50 bps to global GDP and contribute to inflation, depending on the exchange rate fluctuations. In order to mitigate this volatility, the global central banks added 1,045t to global gold reserves in 2024 alone, diversifying their foreign currency asset portfolio, as a safeguard against inflation and currency market volatility.

Just as central banks are diversifying their assets, investors should also focus on asset allocation during such volatile times. Over the past month, the large-cap equity category has seen a fall of approximately -6%, mid-cap -8.5%, and small-cap -11%. In contrast, short-end debt funds have delivered returns of around 7%, while the mid part of the curve has yielded 4-5%. In these times, and over the long term, proper asset allocation is crucial to balancing portfolio returns for investors.

Q: RBI has recently announced directions regarding forward contracts on G-Sec. Will you be trading/using these derivatives? Can forward contracts help in outperforming as a fixed-income fund manager?

A: Forward contracts are mainly used by insurance companies. In mutual funds, where pricing is done on a daily basis and since the delivery of a forward contract is set for a future date, blocking the limit could result in the loss of accruals and exposure to market movements. Therefore, forward contracts may not gain significant traction in the mutual fund industry at present.

Q: What kind of funds do you see outperforming in the mid-to-long term?

A: Debt fund returns are a function of a) Interest rate outlook, b) system liquidity and c) how the fund is positioned. With the RBI recently cutting the rates by 25 bps, a further reduction can be expected in the coming 12-18 months. Additionally, the RBI in recent weeks has implemented several measures to improve system liquidity, however, we are yet to see the full impact of the same. In this context, we believe as the system liquidity neutralises, the yield curve will normalise (steepen). Therefore, a portfolio focused on the mid part of the curve (3-5 years) and the extreme long end of the curve should be well-positioned to maximize the risk-reward potential of the current rate cut cycle.