July 1, 2022
  • July 1, 2022

RBI launches a boost to bond investors

By on May 15, 2022 0

With the repo rate rising, investors can expect a better deal as the Reserve Bank reversed the trend of interest rate lows

With the repo rate rising, investors can expect a better deal as the Reserve Bank reversed the trend of interest rate lows

The Reserve Bank of India’s decision last week to call a surprise Monetary Policy Committee meeting and raise its repo rate from 4% to 4.4% sparked turmoil in equity markets. But this is good news for bond investors.

It shows that RBI and the MPC are finally willing to reverse their three-year policy of keeping interest rates at low levels to help businesses and borrowers survive the pandemic. Savers and investors can expect a better deal on their fixed income products in the coming year.

While the bull cycle has only just begun, interest rates in India may still have a long way to go. Before falling to a multi-decade low of 4%, India’s repo rate was 6% in 2018. It even reached 8% in 2014-2015. Right now, with the RBI walking a tightrope between inflation and growth, market experts believe that repo rates could rise another 75 to 100 basis points (bps) over the course of the next year to reach 5.15 to 5.4%. Although it is the official policy rate, the repo rate itself is of little importance to savers or investors. It is simply the rate at which banks borrow money short-term from RBI whenever they need cash.

So, if you’re a fixed income investor, it’s more useful to know what’s happened and what’s likely to happen to the interest rates of the investment options you use regularly, so you can make the appropriate choices. Here is:

bank FDs

Although movements in RBI repo rates are supposed to send signals to banks, fixed bank deposit (FD) rates are generally quite slow to react to RBI movements, especially when there is an upward trend. .

So despite all the interest rate action in the market over the past year, the SBI’s FD rate for one to two years, for example, has barely risen from 5% in January 2021 to 5.1% now. (last revised February 2022). The FD rates for 2-3 year terms increased from 5.1% to 5.2% and those for 3-5 year terms from 5.3% to 5.45%. Private sector banks such as IndusInd offer a slightly better offer on rates at 6-6.5% for terms of 1-5 years and smaller financial banks such as Equitas offer 6.1-6.75% for similar durations.

But FD bank rates today compare quite poorly to market interest rates and are likely to be revised upwards over the next year. If you’re an FD bank investor, it makes sense to stick to the lowest possible terms at the moment, say six months to a year. This can help you move to much better rates when banks decide to catch up with the RBI and the markets.

Postal regimes

The interest rates for postal schemes such as Post Office Term Deposits, Monthly Income Account, National Savings Certificates (NSC), Old People’s Savings Scheme (SCSS) and PPF are reset quarterly by the government.

For the current quarter April-June 2022, postal term deposits offer 5.5% for 1 to 3 years and 6.7% for 5 years. The Monthly Income Account offers 6.6% and the NSC offers 6.8%. SCSS offers 7.4% while PPF is at 7.1%.

All of these rates are better than comparable bank DF rates. Rates on postal instruments are assumed to be linked to market yields on government securities of different maturities.

Therefore, given that government bond market yields have risen sharply over the past six months, post office plan rates are overdue for an upward revision.

But to protect savers from the sharp drop in market interest rates, the government had not lowered the rates for these devices for two years. When post office plan rates are increased, it increases the government’s borrowing costs because the proceeds from these plans are used by the Centre.

Therefore, you can expect postal system interest rates to rise over the next year, if the bullish rate cycle continues. However, increases may not materialize immediately. If you are looking to invest in postal systems, avoid long-term systems that lock in your money for five years and more, such as Monthly Income Account, NSC, SCSS, etc. it’s best to postpone your investment for a quarter or two until better rates come into effect.

If you are looking to invest in retirement or annuity plans, it would be best to postpone investing until better rates are available.

Government bonds

With the RBI recently allowing investors to open RBI Retail Direct Gilt accounts, ordinary investors have the opportunity to participate directly in government bond auctions. The good news for retail investors is that government bond market yields tend to react very quickly to inflation and other market signals. In fact, over the past year, yields on these bonds have risen well ahead of those on FD banks and postal systems. The attached chart shows that after rising 130 to 200 basis points, current yields on 1-year government securities (gilt) at 5.77%, 3-year gilts at 6.92%, 5-year securities at 7.27% and 10-year securities at 7.47%. These are very attractive rates for the safest bonds on the market, which are centrally guaranteed. Regular income seekers can invest in these auctions if they are willing to lock in their money until these bonds mature. Again, it would be safer to invest in 1-5 year bonds to start with, then move to longer term bonds as rates rise.

Mutual fund

Mutual funds, unlike the above instruments, generate returns both from interest received on the bonds they hold and from gains on bond prices. Most debt funds outperform other options when rates fall. But as interest rates rise, falling bond prices lead to NAV losses in mutual funds. The longer the duration of the bonds held by the debt fund, the lower the net asset value.

Therefore, mutual fund investors today would be better off sticking to debt funds that invest in very short-term bonds less than a year old. Ultra-short duration funds, low duration funds and floating rate funds are the best options.