During its second bi-monthly monetary policy review for 2021-2022, the Reserve Bank of India announced that it would be keeping the main policy rates unchanged. Cash Reserve Ratio (CRR), which refers to the share of a bank’s total deposit that has to be mandatorily maintained with RBI as reserves in the form of liquid cash has also not been subjected to change and stands at 4%. An uptick in CRR could have translated into banks having to lend at higher rates. The apex bank has also kept the reverse repo unchanged at 3.35%. It is the rate at which the RBI borrows money from the banks and is linked to the repo rate.

The RBI’s stances are largely driven by the objective of sustaining growth given the onslaught of the second COVID-19 wave in the country and for keeping inflation under control. The bank also pledged to maintain an “accommodative stance” for the length of time required for the economy to start regaining health and for keeping inflation within the target.

So what does all this mean from the investment point of view especially for debt investments? Here is a breakdown of what this augurs for debt investments.

Moving interest rates is a strategy adopted by central banks to keep inflation in check. This is because inflation and interest rates are inversely co-related. When inflation rates are within the optimum range, there is less pressure on RBI to hike interest rates as opposed to a situation where inflation is galloping and the central bank has to step in to make borrowing more expensive to curb consumption and thus rein in inflation.

In May 2021, the retail inflation jumped to 6.3% in May 2021 from 4.29% in April 2021. The RBI’s targeted range is between 2% and 6%. The minutes of the MPC meeting stated that a spike in the prices of international commodities and the bottlenecks in the supply chain caused by the resurgence of the pandemic can drive inflation higher while a good monsoon can offset that and keep inflation tamed. Besides this the RBI also revised the projected GDP growth in 2021-2022 from 10.5 percent to 9.5 percent. It stated that domestic demand could continue to remain dampened because of the second COVID-19 wave.

All of this indicates that the spell of RBI keeping interest rates low may continue until the economy makes significant recovery. Even though the country’s COVID-19 caseload has declined significantly and the government is trying to vaccinate citizens on a war footing, it will be some time before the RBI hikes policy rates. Hence, markets will continue to remain volatile for a few months.

It is also important to remember that investments in debt mutual funds and bonds are also linked to secondary market yields. Just like equities are traded at stock exchanges, there exists a secondary market for debt instruments too where investors can buy and sell debt funds and bonds issued by the central government, state government or corporates. Basically, the secondary market is the place where securities are traded after all the debt funds and bonds issued by the issuing entity have been sold. Now, the demand and supply of these instruments in the secondary market weigh in on the net asset value of your debt fund. Secondary market yields (yield is the annual coupon rate divided by the current market price of the bond) are impacted by inflation and economic growth.

In this scenario, it is best to invest in high-quality short-term debt funds which have shorter maturity would be less impacted when yields rise. As an investor, you should also avoid taking high credit risks and investing in banking and PSU debt funds can be a wise move at this juncture. Those who have a higher risk appetite and can tolerate intermittent volatility should steer towards dynamic bond funds where the risk profile can be altered depending on the market conditions.

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Mutual Fund investments are subject to market risks, read all scheme related documents carefully.