Interest rate changes – how will it affect you?

After a lot of speculation, which consumed hours of media time, the RBI Governor has obliged most people and cut the rates by an unexpected 50 basis points. This will definitely have an impact on the economy and investors need to look at their strategies based on the changes that this rate cut and others in the near future are likely to bring. In this post, I wanted to outline the more significant effects of a reducing interest rate regime on investors.

The most obvious impact will obviously be on lending rates of loans. Though the banks have not passed on some of the earlier rate cut benefits to the consumers, this time they have been more or less forced to do so. The home loan rates will definitely be coming down and people looking to get new loans should wait for a few weeks to see where the rates settle down for the various banks before making a decision. For existing home loan borrowers, they should choose the option of reducing your loan tenure, rather than the EMI amount. As far as the other loans are concerned my take remains the same – avoid these even if the interest rates look attractive – consumption oriented loans are a bad idea in general.

What will be the impact on the debt instruments? The returns on Liquid funds, FMP, Short term funds will reduce and along with indexation being available only after 3 years, it will start to make less sense to invest in these. Improvement in bond yields will mean that longer duration debt funds will give higher returns and you may want to shift some of your investments to these funds. In general though, for the common investor this debt space is best avoided for the time being. It will be an interesting idea to shift some part of your investments here to an Arbitrage funds. Returns will probably be similar but the tax treatment of Arbitrage funds will now be vastly superior.

What about small savings? Well, my assessment is that the current rates of PF and PPF along with some of the Post office schemes will not be able to sustain the present rates being offered. 8.7 % for PPF will definitely need to come down, though it is not an easy political decision to bring down PF and PPF rates. For starters these would probably be around 8 % in the near future, still giving enough reason for investors to keep the faith in these.

Should you then look at the tax free bonds now, based on the current rates of FD etc. Well, as I have said many times before, FD clearly is a poor choice of instrument. If you are looking for regular income then 7.6 % tax free over the next 15-20 years is really not as bad a deal as many would have you believe. Yes, there is a possibility that inflation may rise in the future forcing RBI to increase rates once more. However, I do not think that scenario is the really probable one and it is far more likely that inflation in India will fluctuate around a mean figure of 5 %. If this happens then you  may well be sitting pretty with a tax free interest of 7.6 %. Just to give a perspective I earn 8.8 % from my tax free bonds and this year that is the best return I have had from all my investments.

However, while loan rates, deposit rates and debt instrument investments are all important, the real impact of this and future rate cuts will be on the larger Indian economy. Companies will start getting funds at a competitive rate and this will boost production. Consumers will have more money in their hands and this will boost consumption hopefully. A combined effect of these two is very likely to ensure a GDP growth of 7 to 7.5 % in this fiscal year. With GST being implemented, a likely revision on personal Income Tax rates and more FDI money coming in from outside, the growth prospects of the economy look even better in the coming fiscal. I will not be surprised at a GDP growth of 8 % in next FY and even 9 % in the year after that, when GST is fully implemented and some of the FDI starts working on the ground.

This clearly means that investors should focus on equity both in MF and stocks. I think in the current state of the market, people not having a stock portfolio should go ahead and start one. For people who are already into one, it is a good time to invest more in their holdings as well as add selective stocks to their portfolio. Over the next few years it is quite likely that the Indian markets and economy will give handsome returns to investors who will keep the faith. However, the ride will not be a smooth one and mechanisms such as standard SIP will have limited utility. Investors will need to be aware of market movements and be agile in taking the appropriate investment decisions.

In the next post, I will share my own investment plans in the changed situation.

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2 thoughts on “Interest rate changes – how will it affect you?

  1. The current reduction in interest rates is mainly to boost consumption and with around 70% capacity utilization no significant corporate investment is expected. It may help highly leveraged companies and hurt cash rich ones. Individuals’ interest income would come down and discourage savings. Consumption based themes may fare well. Effect on consumer durable & EMI is insignificant

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