Interest rates in India are headed for a historic low and implications on individual and corporates will be far-reaching…!
Premise for this statement is threefold: demonetisation, low inflationary regime and forthcoming GST. All three being catalyst for reduction of rates in the economy in short term, medium term and long term respectively. As a precursor, SBI has already announced up to 175 basis point rate reductions in its bulk deposit rates and most other banks will follow suit in weeks to come. For a layman, fixed deposit of 1 year which was fetching as high as 8.5% a year back, will potentially fetch 6-6.5% in few months from now.
Let’s understand this scenario in detail. In the month of September, bank deposit base crossed 100 lakh crores for the first time in country (as reported in Financial Express). Current demonetisation drive is expected to get atleast 10-12 lakh crores into bank. The majority of which should remain in bank balances and deposits for a reasonable amount of time. Simply illustrated, if today the entire banking industry put together has a deposit base of Rs. 100, it will swell in the range of Rs. 110-112in next 2 months, because of demonetised currency being deposited by people at large. Surplus funds to the tune of 10-12% in 2 months, will furnish banks with abundant liquidity, so much so that they will not be interested in offering higher rates to mobilise further deposits. Benchmark 10 year Bond yields in the economy have already fallen by almost 9% from 6.8% to 6.2% in last 10 business days itself, since the announcement of currency demonetisation. And it will not be surprising, if Central bank in its next monetary policy review (due in December) cuts repo/reverse repo rate beyond normal expectations. This indeed, is recipe for a new way of living.
Here’s a quick 5 pointers to assess the impact of this new regime of low interest rates which is likely to usher in sooner than we all anticipate and suggestions to cope with the impact thereon:
1) Tough for savers:
A fall in interest rates is indeed bad for a country which saves 28% of its earnings. As a country, we love to invest (read save) in Fixed deposits, PPF, small savings instruments or just leave our money in Bank savings account. Indians are risk-averse investors and have historically believed in these safe instruments albeit fetching low returns. As per Karvy’swealth survey of 2015, amount invested in these instruments is anywhere upwards of 75 lakh crores. All this will progressively fetch lower and lower returns and is bad news for a nation of savers!
Moral: Start scouting for better investment options other than deposits.
Suggestion: Retail investors should start looking at Mutual Funds as an avenue to deploy savings rather than relying solely on bank deposits & similar instruments.
2) Good for borrowers
However, other side of the story is quite rosy. As a country we also love to borrow. Retail loans (home loans, personal loans, educational loans, vehicle loans, consumer durable loans and credit cards) outstanding for Indian banks during Apr’15-Feb’16 stood at a whoppingRs. 13.75 lakhcrore (Pic 1).All this including corporate credit is bound to get cheaper. Banks will be forced to reduce their base rates and prime lending rates. Though new borrowers will benefit more, buteven the existing ones are bound to reap rich dividends. Whether your personal balance sheet will improve or worsen – depends on which side of the fence you are sitting: borrower or saver!
Moral: Be ready to leverage and start scouting for that dream home!
Suggestion: You are better off today being in a floating rate loan but 6 to 12 months down the line you might want to avail of a fixed rate and lock your outgoing for long-tenor loans.
3) More consumption:
Basic economics tell you that in a falling rate scenario, as incentives to save money reduces, people tend to prepone their purchases and start consuming more. Simply put if you think you can’t earn enough out of your savings, you would rather spend it to fulfil that long-lasting dream of yours! In economic jargon: propensity to consume increases and propensity to save reduces.
Moral: Be prepared to pamper yourself with that luxury holiday or watch. It will not only get cheaper, you will be psychologically more inclined to go for it.
Suggestion: Always follow the equation ofIncome – Savings = Expenses. And never the other way round i.e. Income – Expenses = Savings.Indulgence may be good now but prudence may prove to be a virtue in hindsight!
4) Re-investment Risk:
One of the biggest risks on your already invested fixed deposit or Bond, will be re-investment risk. Everything which is likely to mature in next 6 to12 months, will not fetch you the same rate of return in the future, and will put you in a dilemma when it comes to re-deployment. One has to act swiftly on this and calculate cost of shifting from short-maturity instruments to long-tenor ones thereby locking current rates (which are still reasonable). If you wait for another 6 months to let your deposits mature and then scout for an attractive yield, chances of disappointment are high. Compute your switching cost, do your maths and take a long-term plunge. Whether it is locking in a 5 year deposit or moving debt portfolios from short term maturity to long term maturities, the faster you act, the better it will be.
Moral: Be prepared to take tough calls on your Debt investments.
Suggestion: If you are booking fresh deposits, try and lock in rates for long tenors quickly or go for medium to long maturity portfolios in Mutual funds.
5) Believe in Equity:
Take this with a pinch of salt ! History tells you that stock markets do extremely well in a falling rate scenario, as more money starts chasing risky assets. When you know that risk-free assets (read deposits) are yielding you lower returns progressively, marginal utility of investing that extra buck of your saving in such instruments reduces sharply. Its, therefore, time to believe in Equity as an asset class.
Moral: Do your risk profiling. Understand your risk tolerance and take a calculated dip in Equity to reap long term rewards.
Suggestion: Invest via the mutual fund route for long-term and let experts take a call on markets & asset-classes on your behalf!
Falling interest rate scenario on one-hand will render many investment avenues spineless, yet it will throw open a vastarray of fresh opportunities. If you act smart and nimble, you can use this to your advantage. In nutshell, brace up for lower yields (specially in your fixed tenor debt instruments), be prepared to re-align your portfolios and consumption patterns, deploy your savings wisely and look out for avenues with longer maturities and risk-permitting dabble into equities !
“Opportunities are never lost. If we don’t grasp them, somebody else will. So march out boldly, seize opportunities and shirk not from putting your best foot forward.” – Aditya Vikram Birla