The message from the Reserve Bank of India is clear; interest rates are headed up.
While key indicators have been left unchanged the Bank has increased the rate at which it borrows in the market to control liquidity by 0.25%. Since this was not anticipated, debt markets witnessed a correction in bond prices, across maturities.
Without delving more into the Monetary Policy and the statement, let's get to what concerns us the most.
What does this mean for you?
1. As a depositor
In the financial year ended March 2005, banks lent more money (non food credit) than they mobilised by way of deposits. If the pick up in demand for non food credit were to hold (last year, the growth recorded was the second highest in 55 years), there will undoubtedly be pressure on banks to mobilise more deposits to meet this need. One can expect deposit rates to harden from here onwards.
Ensure that you are not locked into lower rate long-term fixed deposits. Go in for floating rate fixed deposits or very short-term deposits which can be rolled over on maturity.
Another alternative is to park your funds in very low maturity debt funds (liquid, short-term floaters) which offer better tax adjusted returns
2. As a loan seeker
In recent years as the core business of providing credit to industries suffered, several banks made aggressive entries into the retail finance market.
Providing home loans was a core focus area as the ticket size is large and the tenure longer as compared to say an auto or personal loan. The focus was on market share and not profitability. Not to mention the stock markets were looking for 'retail stories'
With interest rates on the rise and the demand for credit picking up (a business banks probably know better), it is probable that the desire to get business at any price will reduce, i.e. irrational pricing behavior may not last.
Instead, it is reasonable to expect rates at which home loans are offered to edge up, though marginally. So, if you are looking at buying a property, do it now!
So should you go in for a floating or a fixed rate loan? The answer to this depends to a large extent on your risk appetite. Floating rate loans are priced cheaper as compared to fixed rate loans; they are lower by about 0.50% to 0.75%.
If you expect rates to increase by more that this amount, it may make sense for you to lock in the cost and go in for a fixed rate home loan. Otherwise, you are still better off with a floating rate loan.
But then this is a call you have to make as your loan tenure will get extended in the event of an uptick in rates, although some home loan companies also give the option of increasing the EMI amount.
3. As a investor in debt funds
It is best that you stay away from long and medium-term debt funds. As interest rates rise, most likely, the worst hit will be such funds.
Park your funds in short-term funds until the debt markets stabilise. Go in for liquid and short-term floating rate funds.
You can also consider parking your monies in short term fixed deposits. But such instruments are no longer tax efficient (Section 80L is now omitted).
4. As a investor in equity funds / markets
Rather than discuss the state of the equity markets and suggest a course of action, let's step back a bit and look at how stock market would react to a rise in interest rates, with all else remaining unchanged. Rising interest rates are usually associated with lacklustre markets (read poor returns).
The reasons:
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Rising interest rates hurt companies by way of higher interest costs. This lowers earnings, which given that valuations remain same, will hurt stock prices.
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Demand for products such as homes, durables and automobiles are driven by availability and cost of credit. A rise in the cost of credit could dampen demand, thus hurting the growth prospects of companies. A slowdown in demand and higher interest rates could also impact investment plans of companies.
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Finally, higher returns offered by debt could lure away investors from the stock markets.
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