The benchmark 10-year government bond yield, which was in the 8 per cent plus zone on December 1, 2014, entered it again on September 4, 2018. It has hardened by 150 basis points (bps) over the past year. According to economists, this high interest-rate environment may persist for the next 18-24 months. Investors need to fine tune both their borrowing and investment strategies to cope with this situation.
Driven by currency weakness and oil: The latest round of hardening of government securities (G-sec) yield was driven by the rupee's depreciation. When the rupee falls, it leads to imported inflation, forcing the Reserve Bank of India (RBI) to hike rates. The G-Sec yield climbs in anticipation of a rate hike.
A number of emerging market
(EM) currencies are under pressure at present. The Turkish lira has declined around 41 per cent year-to-date against the dollar. Turkey has to repay a massive amount of external debt over the next 10 months, creating fears of a debt default. Argentina and a few other EM nations are under pressure for the same reason. Since India too runs a current account deficit, its currency too has declined, though not to the same extent. The hardening of crude oil prices from $72-73 per barrel level to around $77 too has added to the rupee's woes.
Where interest rates head next will depend both on the currency crisis and oil price movements. “If the risk-off scenario continues, and the rupee continues to depreciate, the G-Sec yield could rise further. But if the Turkish issue gets resolved, the trade war abates, and oil prices moderate, the 10-year G-Sec yield could drop below 8 per cent,” says Tushar Arora, senior economist, HDFC Bank. With the economy growing robustly at above 8 per cent, economists don't expect interest rates to soften substantially anytime soon.
Prepay loan to counter rate hike: State Bank of India
(SBI) hiked its marginal cost of funds based lending rates (MCLR) by 20 basis points across tenures, while ICICI Bank hiked its 6-month and 12-month MCLR
by 15 basis points recently. When home loan rates go up, you can opt for a rise in EMI or a rise in tenure. Opting for a higher EMI is advisable, as your interest rate outgo tends to be higher if you opt for a longer tenure. "The first option to counter a rate hike is to prepay a part of the loan. The other is to do a balance transfer to another bank, whose rate is lower than yours. However, do a cost-benefit analysis before shifting," says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor (RIA).
Safety first in fixed deposits: Several banks have hiked their fixed deposit rates in recent times: SBI by 5-10 basis points on July 30, HDFC Bank by 10-60 bps on August 6, and so on. The one-year SBI FD rate now stands at 6.70 per cent (7.20 per cent for senior citizens). "Consider the post-tax return before investing in FDs. Debt mutual funds are a better option for investors in the 20 and 30 per cent tax brackets, especially if held for more than three years, due to the indexation benefit," says Mumbai-based financial planner Pankaaj Maalde. Only a small portion of your FD corpus should be invested in small finance banks, he adds, and co-operative banks are best avoided. Investors may consider corporate FDs of AAA-rated companies, which offer 50-75 basis points more than bank FDs.
Stay predominantly in shorter-term debt funds:
During past crises in the debt market (2008 and 2013), too, global volatility led to fund outflows and currency depreciation. But such episodes were followed by a year of strong performance for debt mutual funds. Right now we are probably in the middle of the crisis. "Invest in a short-term debt fund that has three-year papers as its core holding. If you hold it for three years, you will surely end up with a return of 8.5-9 per cent, provided there is no default," says Mahendra Jajoo, head of fixed income, Mirae Asset Global Investments.
He adds that as the 10-year government bond yield inches towards 8.25 or 8.50 per cent, investors may gradually increase allocation to duration funds, in anticipation of eventual softening.
Those who wish to take higher risk for higher return may take limited exposure in credit risk funds. They can give you a return of around 9 per cent, but be aware that they take exposure to lower-grade AA and A-rated papers. But at least there is a fund manager managing the portfolio, and you get the benefit of diversification.
Investors wanting to circumvent the current volatility in open-end debt funds may opt for three-year plus fixed maturity plans (FMPs). Those investing in AA+ and AAA-rated papers will give a return of around 8 per cent, while riskier ones, investing in A and AA-rated papers, will give a return of around 8.75 per cent. Beware that FMPs don't offer much liquidity.
Non-convertible debentures (NCDs) worth Rs 185 billion are slated to hit the markets. While they will offer higher rates of above 9 per cent, investors should weigh their risks by look up their credit ratings. Avoid putting a large sum in a single NCD, or opting for a long tenure of above three years. For senior citizens, the government-backed Senior Citizens Saving Scheme (SCSS), which offers 8.3 per cent, and the Prime Minister Vaya Vandana Yojana from LIC, which offers fixed 8 per cent return for 10 years, remain good options.