In the mid-term review of the Annual Policy Statement for the financial year 2004-05, announced on October 25, 2004, the RBI has hiked the repo rate by 25 basis points to 4.75%. The hike in the repo rate has the worst effect on the debt market investor. The bank interest rate has also increased. The article talks about the implication of repo rate on various investors and borrowers, with emphasis on the debt market.
"There will be no change in any of our deposit rates or lending rates. The repo rate hike will affect only the short-term rates in the money market. There will be no change in our prime lending rate (PLR),"
-M Venugopalan, CMD, Bank of India.(An interview with the Business Standard).
The debt market is poised to be in trouble according to the prediction from the mid-term review of the monetary and credit policy. With the hike in the repo rate by 25 basic points (bps), the bond prices went down (due to increase in the yield). The one week return as of October 29, 2004, shows that in the debt medium-term category the worst return was -0.87% and in the gilt medium and long-term category, the worst return was -1.25%. The worst effect was experienced by the investors of debt fund, mainly the mutual fund and the bankers who have huge exposure in the market during this period. Although, the market as a whole was anticipating a rise in interest rates and most of the fund managers were positioned on huge cash positions. These cash positions were not adequate because Net Asset Values (NAVs) of all debt funds came down. Before discussing the implication of change in the repo rate on various markets, let us familiarize ourselves with the structure of debt market in India and how it works.
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