Though there is some breathing space in the hands of the investors here in India, it is time to carefully study the broad picture.
As expected US Federal Reserve raised interest rates in its last meeting in CY2017 by 25 basis points. China followed the USA and increased short term interest rates quickly. While the largest two economies in the world decided to raise interest rates, it is an indication that the ‘free money’ or the low interest rate regime is over. Though, in India, we have seen RBI keeping interest rates unchanged in its recent monetary policy, it may not be too long for the central banker to decide to pull the trigger of a rate hike. “In a situation of global tightening the RBI has decided to keep the interest rates positive. Other things remaining the same if inflation remains within the prescribed limits, we may see RBI raising interest rates in the second half of the CY2018,” says Dwijendra Srivastava, CIO-debt, Sundaram Mutual Fund.
For the uninitiated US Federal Reserve, the central banker to USA, decided to raise the policy rates by 25 basis points and projected for three more rate hikes in CY2018. China also nudged the rates upward to prevent any capital outflows and called the rate hike more symbolic than substantive in nature. When the interest rates in developed market go up as compared with emerging economies, other things remaining the same, the capital prefers to run to developed markets given the less risk involved.
Theoretically, it makes a strong case for the money to flow back to USA. However, most market participants believed a 25 basis points hike is in the price. And going forward depending upon the numbers in the US and the US Federal Reserve commentary the markets will adjust. “India being a high growth market, may not see large outflows,” opines Srivastava.
Though there is some breathing space in the hands of the investors here in India, it is time to carefully study the broad picture. “Interest rates have already bottomed out. Rising commodity prices, especially crude oil will ensure that we see higher inflation. Fiscal deficit too is expected to worsen from here,” points out Ashish Shanker, head- investment advisory at Motilal Oswal Private Wealth Management. Retail inflation in India soared to 4.88 from 3.63 percent a year ago and 3.58 percent a month ago. Rising oil prices and vegetable prices are seen as a culprit. If the inflation remains strong then there is a case for rate hike to ensure positive real interest rates. Real interest rates is arrived at by deducting inflation number from the nominal interest rates.
Another risk to the benign interest rates in the domestic economy is the possibility of government loosening its purse’s strings as we approach elections in 2019. More government expenditure may put the fiscal deficit off the track. This should make the government borrow more and the higher demand for credit by the government should also push up the interest rates in the domestic economy. India benchmark 10 year G-sec yield hit a low of 6.18% on December 7, 2016. The low was recorded at a time of abundant liquidity caused by announcement of demonetisation. However, the yields are on their way after that and currently quote at 7.15 percent.
Rising interest rates make most investors worried about their investments in fixed income space – especially in bonds and bond funds. When the interest rates go up, the bond prices fall and that leads to market to market losses for the investors. Over last one year long term gilt funds as a category posted an average return of 3.4 percent. Over last one month the funds lost 0.4%. Gilt funds saw a net outflow of Rs 846 crore in the month of November 2017, says the monthly data released by AMFI.
“If your investment horizon is 12 to 18 months stick to short term bond funds,” advises Srivastava.
Ashish Shanker recommends investing in accrual funds and credit opportunities funds. “Stay away from all funds that employ duration as a strategy. If you are risk averse investor stick to short term bond funds that focus on accrual. If you are keen to take a bit extra risk, consider investing in credit opportunities funds,” he adds.
If you are a bank fixed deposit investor avoid locking your money in long term bank fixed deposits. Instead opt for one year fixed deposits. If the interest rates go up next year, you will get an opportunity to benefit from them when the deposits mature. If you have been laddering your fixed deposits – that is investing in fixed deposits of varying maturities, then you will get opportunities to deploy your maturity proceeds of previous fixed deposits at various point of time and the impact of interest rate risk is minimised.
While the discussion on the investments may go on, one should not ignore his liabilities – especially if one is sitting on a large loan liability such as home loan. If the interest rates in the economy are going to go up, then the loans too will charge more interest. “The banks may not raise interest rates on home loans till March 2018,”says Sukanya Kumar, founder of RetailLending.com. This will surely offer some breathing space for the home loan borrowers. But the time on hand should be used optimally to study the loan market and your home loan if you see your home loan’s rate of interest is much higher than the rate available in the market.This could be the time to buy your dream home. But if you are funding your home purchase with a home loan, do not overlook interest rates. “If you are worried about a possible hike in interest rates, you may opt for a home loan that is fixed for a few years and then charges a floating rate. If you can’t get such a home loan, then opt for a floating rate home loan with 12 month MCLR,” advises Sukanya Kumar. The 12 month MCLR linked home loans let the bank revise the interest rates only after 12 months.