Insights

Rate cut to provide benefit to your loans and your investments

April 5, 2016 . Vidya Bala

The RBI, in its first bi-monthly Monetary Policy Review for 2016-17 cut repo rate by 25 basis points to 6.5%. It also cut the Marginal Standing Facility (MSF) used by banks to borrow from the RBI for overnight funding requirements against their government security holdings – by 75 basis points to 7%.   It raised the reverse repo rate by 25 basis points to 6%.

The debt market gave a thumbs-up to the rate cut with the 10-year gilt falling from 7.43% to 7.39% before settling at 7.41% levels. The equity market, though, appeared confused, perhaps disappointed with the quantum of rate cut.

What it means

With the present rate cut, the RBI has cut a total of 150 basis points since the beginning of 2015 when rate easing began. The rate cut, together with the ongoing liquidity injection measures including MSF means that banks will have easier access to funds at reasonable rates. That also means they would have little choice but to up the pace of rate transmission to borrowers.

Impact on debt funds

The rate cut can be expected to benefit all medium to long duration debt funds, holding both gilt as well as corporate bonds. A fall in gilt yield will provide capital appreciation opportunities. It will also narrow the spread between gilt and corporate bonds, thus providing bond appreciation as well.

Gilt and dynamic bond funds have already seen as much as 3-4 % appreciation beginning 2016. This was a result of long term rates (10-yer gilt) falling from 7.76% in end December 2015 to 7.43% over the past 3 months. However, we do not expect any upfront gains from such a yield fall. Gains are likely to be spread out this financial year and a few months into the next fiscal as well as inflation, monsoon, and impact of pay commission provide more data points for RBI’s future moves.

While short-term rates will eventually ease (as the impact of using marginal cost of lending for new loans kicks in), short-term debt funds holding short-to-medium bonds will still stand to gain from the rate ease as the bonds they hold may see a price appreciation. However, in the near term, the reverse repo rate hike will hold up short-term rates thus keeping your ultra short and liquid fund rates reasonbly stable for now.

Good entry point for investors

With lower bank rates and lower small-saving rates, long-term investors have little choice but to diversify into income funds for superior returns and tax efficiency.

While the gain over the next few months may be better felt in funds with longer average maturity, we believe more sustained returns will be had from income accrual funds investing in corporate bonds. Hence investors looking for long-term exposure can consider a combination of dynamic bond and income accrual funds to gain from a rate rally and a more sustained accrual and re-rating rally (of bonds).

For those having long-term loans, the current rate decline regime can free up some funds for investing. A rate cut in long-term commitments such as home loans (base rates for existing loans will also eventually fall, even as the immediate rate cut benefit will be seen for new loans following MCLR) would also free up some money in the hands of the investor. A 30-50 basis point rate cut for a 15-year home loan for instance can free up at least Rs 1500-2000 more for you to invest. Investors must plough such surplus in equity funds through SIPs. The current equity market also provides ripe ground for averaging.

Comments

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4 thoughts on “Rate cut to provide benefit to your loans and your investments

  1. Hi Vidya,

    as you have suggested recently can we put the additional investment now ? or shall we wait for some more big falls like today.

    Thanks.

    1. Hello Karthick, You can make additional investent now and in 2-3 further tranches. Not in one go now. Vidya

  2. Hi Vidya,

    For Ultra Short Term debt fund: What would be the strategy going forward? good time to invest here now or look for other options.

    1. Hello Sandeep, Sorry for the delayed response. Ultra short-term funds will see lower returns as rates all. Their purpose should be to park short-term money (6 months to a year) and not view it as a long-term option like FD. thanks, Vidya

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