The Reserve Bank of India, the country's central bank, generally surprised the markets by leaving interest rates unchanged in its Monetary Policy announcement on Tuesday.
It was widely expected that the inflationary pressures and rapid growth in non-food credit would prompt the RBI to hike short-term interest rates.
Our view at Personalfn remains unchanged - interest rates will rise during the course of the year. While the RBI may not have increased the short-term interest rates in its tary Policy announcement, the fact is that deposit rates offered by banks and the yields on long-erm debt instruments have risen significantly since the January policy announcement. Expect interest rate hikes as the year progresses.
So how does the policy impact you?
If you are taking a home loan:
As interest rates rise, so will the cost of the loans. For the high networth individual who was so far able to wriggle out a special discount on the home loan interest rate, the situation is likely to change for the worse.
The RBI has significantly increased the general provisioning requirements on all home loans over Rs 20 lakh (Rs 2 million). This is likely to impact the cost of such loans.
Our recommendation to the loan-seeker is to consider opting for a loan which has an initial period during which interest rates are fixed. While we expect interest rates to rise this year, we do not see any such concerns from a long term perspective. In fact as the market matures and differential pricing is introduced, a borrower with a good track record may benefit from lower cost loans.
However, if you do not have an appetite for risk, we recommend you go in for a truly fixed-rate home loan.
If you invest in stocks:
The RBI has projected GDP growth (real i.e. not including inflation) in the range of 7.5% - 8.0%. This is very encouraging as it comes on the back of 8.1% projected growth in the last financial year.
At gross levels (including inflation), this translates to a growth of about 13% pa; this is in line with our long term expectation of domestic growth. A robust economy augurs well for corporate India. As companies grow, their corresponding growth in profits or the lack of it, will reflect in stock prices over a 3-5 year timeframe.
Rising interest rates, however, could prove to be a dampener for further expansion in stock market valuations as the relative attractiveness of debt improves. In recent years money has moved from debt to equity on account of the favourable risk-reward scenario; however, with valuations for the BSE 30 already at about 18-20x, the earnings yield (total profit/total market value) on the stock markets has declined considerably, to about 5.0% (from a high of over 12% as recently as three years back).
The yields on domestic debt instruments, however, have risen from under 5.0% to about 7.5% today (for a ten year debt instrument); in fact one year deposits today are available for as high as 8.0%!
Even the yield on global debt instruments is on the rise (and further rate hikes are expected). In light of this, there is a possibility of some money, at the margin, beginning to flow back into debt.
Our recommendation for long-term investors is to enter the stock markets via Systematic Investment Plans (SIPs) that are offered by almost all mutual funds. This will dilute the risk of you mistiming the market.
Also, before committing more money to the stock markets ensure you are in line with your planned asset allocation. Lastly, avoid investing in sectoral funds.
If you invest in debt:
The current policy announcement probably will not have much of an impact on interest rates (remember, the RBI has not changed any of its key lending/borrowing rates or made adjustments to its liquidity controlling tool, the Cash Reserve Ratio).
However given that the demand for money from the industry and retail borrower is on the rise (the RBI predicts non-food credit will grow 20% year-on-year) and deposit growth is sluggish (unattractive returns?), expect interest rates to increase still further from present levels.
To benefit from this rising interest rate cycle, avoid committing funds to long term deposits. Instead opt for short-term deposits and roll them over so that you benefit from any rate hike.
Better still would be to go in for liquid/money market mutual funds; such schemes offer very attractive tax-adjusted returns with the added benefit of liquidity.
If you are an NRI:
The RBI has increased the interest rate ceiling on NRE deposits of one to three year maturities by 0.25% to 1.00% over the LIBOR rate for US dollar with corresponding maturities. Your deposits will now earn more!
Our recommendation to NRIs is that they should not look at India either from a stockmarket opportunity perspective or a place where all their risk-free money needs to be parked (read deposits). Over time, they could be disappointed on both counts.
The best way to benefit from the investing opportunities available to an NRI is to draw up an asset allocation plan which factors in various things like risk profile, returns and settling down post-retirement and then invest in line with it.
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