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.
| ADAPTING TO IT
Here are some tips for investing
in a low interest-rate environment.
lock money in long-maturity debt
out floating-rate debt, if available
of the risks in high-interest debt offers
long-term loans (for home etc.,) now
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.
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
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
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
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
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.