Targeting inflation
In 2008 the focus was inflation targeting. We had to bring down inflation. Now things have changed. Inflation has cooled -- not necessarily as the result of RBI policies alone but due to a combination of local/ global factors. This has led to another problem that of lesser growth in the economy.
While high rates help to control inflation, they also stop companies and individuals from borrowing, and this in turn leads to reduced growth, which we are witnessing now.
So now the objective of RBI is to pump prime the economy and get growth back on track. This can be done if companies and consumers borrow from banks and spend. To make loans attractive, it is imperative for the cost of loans to be down. Interest rates are nothing but cost of loans and hence RBI is steadily reducing interest rates by reducing CRR and reverse repo rates. As mentioned earlier, our next article will focus on explaining these terms as well as how prices of bonds rise and fall taking cue from interest rates.
Looking at the chart on the first slide, we can infer that as interest rates came down (or more importantly as market expectations of rate cuts increased), gilt funds' performance started improving.
A conclusion here is that 'as interest rates go up, bond prices go down and bond prices move up as the last two are inversely related'.
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