The RBI policy announcement on 5th April, 2016 was actually a very progressive one. However it is quite unfortunate that the stock market reacted quite adversely.
Let’s understand the central bank’s monetary tools from an economic perspective. So essentially whenever the Central bank feels that the inflation is controlled in the economy, there is need to propel growth and to kick start the economy, the central bank uses its monetary tools. Essentially a repo rate cut is supposed to infuse liquidity and release a huge amount of money in the system. Further reduction in the marginal standing facility also tends to reduce the cost of borrowing for banks and adds to the liquidity in the system. The reverse repo hike is to safeguard funds. So banks, while they do not find avenues to deploy the money, can safely park the same with RBI in the interim.
As a result of such rate cuts, profitability improves for companies who are highly leveraged and have borrowed a lot of money. By reduction in interest costs, profitability automatically tends to improve. Thus as an immediate effect the stock market should improve as stock prices rise due to the potential of improved profits. For consumers who have either borrowed or who intend to borrow it is quite likely that now the loans will be much cheaper.
One must also not ignore the benefit of the new MCLR lending system which has to be adopted by banks with effect from 1st April, 2016. As a result of this action the cost of borrowing for consumers is already down by about another quarter to half percent.This tends to increase the demand for goods and services and thus creates further liquidity and movement of money in the economy. So one should wait for effects of such monetary measures to translate into benefits for everyone in due course of time. It is also observed that often a rate cut is followed by a rally in equity market. So one should keep an eye on that as well and not be perturbed by volatility in the stock market which could happen due to a variety of reasons.
With reduction in rate cuts, debt funds will come in the limelight. Debt funds invest the money in a portfolio of fixed income instruments having different maturity periods. This will help the investor to have exposure to a basket of fixed income instruments instead of investing in a single fixed deposit. This will help the investor to earn comparatively better than fixed deposits. As the secondary market is relatively illiquid, investors can consider investing into bond markets through FMPs, liquid funds and ultra short term funds.