Expected but unscheduled. What does RBI’s rate hike mean for investors and borrowers?

The rate hike by the Reserve Bank of India (RBI) was expected but was unscheduled. Hence, it took everyone by surprise. Perhaps, the RBI wanted to send a message of urgency to tame inflation fears and keep it within its comfort band, and decided to not wait till its upcoming policy meeting in June.

The repo rate has been hiked by 0.40 percent to 4.40 percent now. But this is just the beginning of the rate hike cycle and not a one-time uptick. The RBI Governor reminded us that the current hike is a reversal of its stance at the start of the pandemic, which triggered an ultra-accommodative stance. The RBI had cut rates from 5.15 percent in 2020.

So, if the interest rate cycle has finally turned and rates are expected to move further up, what does it mean for depositors, investors and borrowers?

There was a lot of hue and cry in recent times about the low rates fixed deposits (FDs) were offering. This is set to change now.

The start of the rate hike cycle means that, initially, the interest rates on short-term FDs will increase. The rates offered by long-term deposits will take a bit more time before they see some good upmove.

For the time being, do not lock your funds in long-tenure FDs. The rate hikes have just started. So, avoid locking your deposits for the long term currently. Wait for rates to increase further before locking higher rates for a longer duration via multi-year deposits.

Also read | RBI hikes repo rate by 40 bps: How is it going to affect borrowers and depositors?

Interest rates are not the only factor that drive stock markets. Lower rates in the past have meant that there were ample liquidity, something that equity markets love.

Now, with the rate hike, investor sentiments will take a hit first. The announcement itself led to a mayhem in the market within an hour. Also, as rates increase, the rate-sensitive companies and sectors get impacted.

If that’s not enough, the US markets will also face headwinds, going forward, as the Fed starts its own rate hikes, which has an impact on all markets.

So, without any fresh positive triggers (and too many negative undercurrents like war, inflation, etc.), equity returns may suffer in the short term. If you are an equity investor, better reset your return expectations accordingly, for the time being.

A rise in interest rates will have a negative impact on debt funds, with a portfolio of longer duration. So, it’s best to avoid funds of longer duration for the time being.

If you have to park fresh money in debt, stay on the shorter side of duration. That is, stick to fund categories like liquid, ultra-short duration, low duration, and money market funds.

If you already hold an all-weather portfolio made up of debt funds of different maturity profiles, stick to what you already have. Do not make adjustments unnecessarily. If you have doubts about whether your debt fund portfolio is rightly positioned or not, consider talking to an investment advisor.

If you have an existing floating-rate home loan, you will see the impact first as lenders are quick to pass on the rate hikes to borrowers. This doesn’t exactly mean an increase in EMIs. Some lenders just increase the loan tenure, quietly. But that may cost you more in the long term. So better to check with your lender and have your EMI increased, instead, if you can afford it.

If you were planning to take a fixed-rate loan (like auto, personal loan, etc.), better do it soon. Further rate hikes will push up loan rates in the coming months.