Interest Rate Changes and Duration Management
| Case Code: FINC177
Case Length: 13 Pages
Pub Date: 2021
Teaching Note: Available
| Price: Rs.400
Industry: Wealth Management
Themes: Portfolio Management, Fund Management, Risk Management, Investment Decisions
Abstract Case Intro 1 Case Intro 2 Excerpts
March 2010-October 2011 (Increasing Interest Rate Scenario)
During this period, the RBI focused on hiking rates to control inflation. In March and April 2010, the RBI increased the repo and reverse repo (rate at which the central banks borrow from banks) rates by 25 basis points each to 5.25% and 3.75% respectively. The government’s decision to deregulate oil prices added to the inflationary pressures, increasing the expectations of a rate hike by the RBI. Again, on July 2, 2010, the RBI further hiked the benchmark rates by 25 bps to 5.5% and 4% respectively. In its first quarter review on July 27, 2010, the RBI increased the repo rate and reverse repo rate by 25 bps and 50 bps to 5.75% and 4.50% respectively..
April 2012-May 2013 (Decreasing Interest Rate Scenario)
After a tight interest rate regime during 2010-2011, the RBI took a different stance and started reducing the benchmark rate. This was basically in response to oil prices stabilizing and also questions being raised on the sustainability of economic growth in India. In its policy review in April 2012, the RBI, for the first time in 3 years, cut the repo rate by 50 bps to 8%. The yield on 10-yearGilt fell to 8.390% in June 2012 as against 8.588% at the end of March due to a higher-than-expected decrease in the repo rate by the RBI in April. The demand for safe gilts went up and prices increased due to weak global sentiments and the slowdown in domestic economic growth..
September 2013–January 2014 (Increasing Interest Rate Scenario)
During this period, the monetary authority again changed its focus toward tightening the policy rates. The yield on the 2023 Gilt bond rose to 8.761% by the end of September 2013 and further to 9.12% by December 2013. This resulted in a fall in its price due to the monetary policy being tightened with the increasing of the repo rate in September and October 2013 by 25 bps each to 7.75%, as a measure to curb inflation..
January 2015–August 2017 (Decreasing Interest Rate Scenario)
The RBI cut the repo rate five times by 200 bps from 8% to 6% from January 2015 to August 2017 due to the easing inflation and subdued growth. Gilt prices gained with the yield on the 10-year paper falling to 7.736% on March 31, 2015, compared with 7.857% on December 31, 2014, as the RBI reduced the repo rate by 25 bps each in January and March 2015 to 7.5%. The gain in bond prices was further fueled by the lower than expected inflation and sharp rise in the rupee against the US dollar. Gilt yields fell to 7.86% by June 30, 2015, due to the RBI’s further rate cut to 7.25% in its June policy review..
June 2018–August 2018 (Increasing Interest Rate Scenario)
The RBI increased the repo rate two times by 50 bps from 6% to 6.5% from June 2018 till August 2018 to combat the rise in inflation due to an increase in crude oil prices and the falling rupee. Gilt prices fell with the increase in the 10-year bond yield from 7.903% to 7.951% during the same period..
February 2019–May2020 (Decreasing Interest Rate Scenario)
The RBI cut the repo rate by 250 bps from 6.5% to 4% from February 2019 till May 2020 to boost economic activity. Across the globe, central banks followed the stance of following a liberal monetary policy as protection from the global economic slowdown caused by the worsening US-China trade relations. Subsequently, the central banks continued to follow an accommodative policy to strengthen economies amidst the COVID-19 crisis. The first quarter of 2020-21 reported the worst ever GDP contraction at -24.4% in India. Ten-year Gilt prices rose with the fall in yield from 7.591% in February 2019 to 6.013% in May 2020..
Exhibit I: Repo Rate Changes by RBI
Exhibit II: Growth Rate of Quarterly Estimates of GDP at Constant Prices
Exhibit III: 10 Year GoI Bond Yield
Exhibit IV: ICICI Prudential All Seasons Bond Fund
Exhibit V: Duration of ICICI Prudential All Seasons Bond Fund
Exhibit VI : YTM of Government Bonds
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