SEPT. 15, 2002
 Cover Story
 BT Event
 Personal Finance
 Case Game
 Back of the Book

Q&A: Douglas Nielson
Douglas Nielson, Chief Country Officer, Deutsche Bank, India, speaks to BT Online on what the bank has in mind for India, particularly its plans in the asset management arena. Equity research, as Nielson says, will emerge as a key differentiating factor in this business, and that's exactly what Deutsche is working on.

Long Bond Is Back
The government is bringing back the 30-year bond. Will insurers be the only takers?

More Net Specials
Business Today,  September 1, 2002
Interest Low Down
Interest rates in India have been at historic lows for quite some time now. What this implies to you as an investor.

Interest rates in India are at historic lows. Money supply is good. The RBI's bank rate is down to 6.5 per cent. The yield on the 10-year government bond, another benchmark, is down to 7.2 per cent. In the commercial paper market, some corporates are said to be picking up short-term funds at just 6.3 per cent.

The effect on risk-bearing loans is even more amazing. Banks are giving out loans (of the few being given) below their prime lending rate (PLR), which, if it remains a double-digit figure at all (11-12 per cent, typically), seems to be mainly for purposes of form rather than function. Borrowers have never had it so good.

It goes without saying that inflation, at around 2.5 per cent, remains subdued too. That still leaves real interest rates in the 4-6 per cent range-stunningly low for a country with a fiscal deficit nudging double-digits.

That the Indian government favours a low-interest regime is obvious-not just to reduce India Inc's cost-of-capital to competitive levels, but also to lighten its own burden. The government, remember, is India's single largest borrower of money.

Here are some tips for investing in a low interest-rate environment.

» Don't lock money in long-maturity debt
» Seek out floating-rate debt, if available
» Beware of the risks in high-interest debt offers
» Take long-term loans (for home etc.,) now
» Use MFs to access wider opportunities

High fisc, high liquidity, low inflation, low interest. How does any of this add up?

Corporate sluggishness, as reflected in the anaemic credit pick-up. With the 1990s' capacity build-up so excessive, new projects have become scarce. "The current situation is such that the investment climate is bad due to slump in the business scenario," says Milind Nandurkar, Fund Manager (Debt Segment), Sun F&C Mutual Fund, "the banking system is flush with funds, and the deposit rates are low."

Corporate working capital requirements are also low, these days, on account of efficiencies wrought all along the value chains. And with corporate loan-seekers so few, India has a lot of money stuffed in vaults looking for deployment. It's what experts call a 'liquidity overhang': more cash to go around than anybody knows what to do with.

Says Sandesh Kirkire, Debt Fund Manager, Kotak Mahindra Mutual Fund, "While manufacturers are now borrowing less, forex inflows are smooth. Banks are lowering deposit rates to protect their spreads."

And to top it all, as the dollar weakens internationally (the US benchmark rate is at a 40-year low), any RBI effort to prevent the rupee from appreciating involves injecting more liquidity into the domestic system, which could potentially send Indian interest rates even lower.

Bottoming Out

But that doesn't mean that the rates will go lower. There's reason to suspect that rates are pretty much near their floor, given the market conditions. For one, anything much lower, and economists might start worrying about a 'liquidity trap' (rates so low that people simply sit tight on their cash).

Market players don't expect it to come to that, though. This is because the ongoing drought could push up inflation or the fiscal deficit (or both)-putting a floor under interest rates. Explains Ajit Ranade, Chief Economist, ABN Amro Bank, "There is some evidence of inflation creeping into the system on the back of the drought. This could arrest a further fall in interest rates."

Note that the recent government cuts in interest did not boost bond prices much, indicating that the market detects oncoming inflationary pressures (crude oil, by the way, is firming up again).

Moreover, if the recession shows signs of ending, credit demand could possibly revive. "There is a possibility of a demand pick-up around the Diwali time, interest rate could start moving upwards then," says Ranade, though expecting only a minor rise, if at all, since "we can't be out of sync with global rates".

The US, remember, is in danger of slumping again, into what's being called a 'double dip' recession-complicating the job of Alan Greenspan, the Federal Reserve Chairman, who might need to cut the US benchmark rate yet again. To a large extent, the global interest rate trend is so hard to call because the US economy remains so uncertain (deflation is the new scare).

You, the investor, however, have decisions to make. Given an uncertain interest rate scenario, what should you do with your investments and borrowings?

Gaining From It

Calling the interest rate trend might be tricky. But there are tricks for such circumstances too. In the opinion of experts, the best option is to 'Borrow long term, Lend short term'.

For a small low-risk investor, it is best not to lock money in savings instruments of a long tenure (you won't get a good enough rate). So, go for short-maturity bank fixed deposits, debentures and bonds. If you do go for longer-tenure instruments, try ensuring that your returns can rise when the rates do. "Since interest rates are determined by the market, it is better to go in for floating interest rates wherever available," says Nandurkar.

Yes, higher-rate options may come your way in the form of corporate instruments, but it's advisable to watch out for the risks involved (you could lose your capital). When times are bad, default rates are higher too.

On the other hand, low rates mean that if there is anything for which you need a long-term loan (say, a 20-year home loan), now is the time to take it-because you can benefit from today's low interest rate level for decades to come (India doesn't have floating-mortgage schemes).

The latest Union Budget lowered the risk measure that is attached to a home as an asset, which has made it easier for banks to advance home loans. "With the tax advantages considered," says Kirkire, "the cost of a home loan is just about 8.5 per cent (per annum) today, which is a steal."

Letting MFs Do The Job

The bad news for a small investor is the inability to build a portfolio with the widest possible array of debt assets. Lending short-term sounds nice, but is awfully hard to implement without institutional backing.

Institutional players, by the way, also make money trading bonds in the secondary market, where falling interest rates correspond with higher prices (and thus lower yields) of earlier-issued bonds. The past two years have seen debt-based mutual funds (MFs) make a lot of money on bonds.

In other words, it might be better to let the MFs do the job for you. "The advantage is doublefold," says Kirkire, "One, if the interest rates remain soft, you have better returns. Two, if the interest rates go up on account of hardening oil prices, global recovery or any other international factor, you have complete liquidity with mutuals, unlike bank deposits where there is a penalty to break a deposit."

Agrees Nandurkar: "In an mf, portfolios are actively managed, taking advantage of trading opportunities available in the market." An mf, in fact, is a good way to avoid locking money in (a low-paying debt instrument) for a long period.

Of course, you could choose to invest your money the way you want on your own accord. Some advisors recommend a Sensex-mirroring equity portfolio (like an index fund) on the logic that with this index close to an eight-year low, and the average P-E so attractive, it could pay off eventually.

Whatever you do, just remember that Indian interest rates are now influenced by more factors than ever before.