The Reserve Bank of India has spoken. It wishes to grant Indian investors increased access/flexibility to international markets. To that end, a lot of its measures are explicitly aimed in that direction.
From the retail investor's perspective, there are at least 3 points in the Monetary Policy that we have marked for special mention. In a policy statement that otherwise deals mainly with macro issues, these are the measures that can impact your finances significantly. We have given our view on the points with a clear-cut action plan for the investor.
1. Rates on NRI deposits reduced
In a bid to curtail dollar supply (and thereby tilt the appreciating rupee-dollar equation), the RBI has reduced the peak interest rate offered on FCNR (B) deposits (Foreign Currency Non-Repatriable) as well as on the NRE deposits (Non-Resident External) by 50 basis points each.
With this move, bank deposits are no longer as attractive for NRIs. Given the rising bond yields in the Indian debt market, debt funds and fixed maturity plans (FMPs) assume a more important role for the NRI investor.
NRI deposits get the thumbs down
| FCNR Deposit | NRE Deposit | |
| HDFC Bank | 4.47% | 5.22% |
In our view, as bank deposits turn unattractive for them, it is time for NRIs to explore the mutual fund route. Long-term debt funds (especially of the floating rate category) are candidates for investment.
These funds are well-placed to counter an uncertain interest rate scenario and if interest rates rise (which is possible, in our view), then floating rate funds are your best bet.
Floating rate funds are an option
| Pre-Tax Return | Tax Rate | Effective Return | |
| NRE Deposit | 5.22% | Nil | 5.22% |
| Floating Rate Funds | 7.00% | 10% | 6.30% |
Many floating rate funds have given a return in excess of 7% over the last 12 months, which admittedly is a backward-looking metric, but tells the investor how much he would have gained by investing in them (i.e. post-tax return of 6.30% over a year) vis-à-vis NRI deposits.
Another mutual fund investment that merits mention is the fixed maturity plan (FMP). In an FMP, the fund manager locks the yield by investing in a bond with a definite investment tenure (i.e. the maturity is fixed). In times of rising bond yields (like now, for instance), the fund manager can lock-in bond yields at attractive levels.
FMPs are even more attractive
| Pre-Tax Return | Tax Rate | Effective Return | |
| NRE Deposit | 5.22% | Nil | 5.22% |
| FMPs | 9.50% | 10% | 8.55% |
At present, FMPs with a 1-year tenure are offering yields hovering around 10% (pre-tax), although in our illustration we have assumed a conservative rate of 9.50%. Compare this to the rates on NRI deposits and you will realise that even after accounting for the exchange rate differential, there is a strong investment case for FMPs.
2. AMCs can invest in overseas markets upto US$ 4 bn
The RBI has hiked the investment ceiling for AMCs (asset management companies) in overseas stock markets from US$ 3 bn to US$ 4 bn. There is considerable interest in the media whenever this investment ceiling is raised. To be sure, it has been raised several times, but most AMCs aren't excited enough to start investing abroad as yet.
There are two reasons for that. One reason is because AMCs point out that Indian stock markets have grown (and will likely grow) a lot more than most other stock markets. So why invest abroad and lose out on the great Indian opportunity.
This argument is only partly rational; investments aren't just made for growth opportunities, there is a diversification angle to it. By investing in the global stock markets, AMCs, for their investors, can diversify their risks across other currencies/economies so that a downturn in any one of them will not prove detrimental to the entire portfolio.
Another reason why AMCs are not enthused with the idea of investing in global stock markets is because of the taxation angle. A fund must invest in Indian equities (upto a minimum of 65% of net assets) to qualify as an equity fund from a taxation perspective.
So taxation-wise, a global equity fund like the Principal Global Opportunities, which invests 100% in global equities, qualifies as a debt fund (and therefore does not benefit from zero capital gains tax on long-term gains)! In our view, unless this anomaly is addressed, both AMCs and investors are unlikely to view this opportunity with the interest it deserves.
3. Risk weightage on home loans is reduced
Put simply, the RBI, by reducing risk weightage on home loans, has paved the way for banks to lower provisioning for home loans. This implies that effectively banks can reduce rates on home loans, but we believe that it is unlikely to happen at this stage.
Most likely, banks will continue to offer home loans at existing rates, unless RBI reduces interest rates in the next Monetary Policy review.
By Personalfn.com, a financial planning initiative. It can be reached at info@personalfn.com. Personalfn.com also publishes a free-to-download financial planning guide, Money Simplified. To get a copy of the latest issue -- Real Estate & You - please click here.
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