The RBI has raised the repo rate by 25 bps, first time in the last four years. Between 2014 and 2017, we saw the repo rate getting reduced seven times. Consumers benefitted by the way of cheaper loans. But they also earned poorer returns on fixed deposits and small savings scheme such as PPF, which returned their lowest in several years.
In anticipation over interest rates to increase, banks had proactively increased the interest rates on deposits and loans even before the RBI announcement came through. This also came in a bid to grow deposits amidst shrinking liquidity of cash. Let’s take a look at what consumers can do to make the best of this situation.
Exit Long Term Debt Funds
Debt Mutual Funds come in various categories. Given the current macroeconomic scenario, it would be best to pick only liquid funds or short-term funds. These would continue to deliver moderate returns with none of the volatility of long-term funds. Interest rates have an inverse relationship with bond yields. Long-term bonds are most volatile during an interest rate rise. To avoid losing money, you should immediately shift to funds with securities of shorter maturity periods.
Interest rates on loans have risen only marginally. This is still a good time to take a long-term loan for a home or a car as these loans are still attractively priced in the 8.5 per cent range. Before they rise further, you can take a new loan to fund your purchases. If you’re paying a higher interest rate (say, 9 per cent or more), you can still consider refinancing your loans and move to cheaper ones.
Exit Low-Rated Bonds & Deposits
You may have purchased debt instruments – corporate bonds or corporate deposits. They have with credit ratings. The safest such securities have the highest ratings – AAA, AA, A, A+, etc. Riskier securities have lower ratings – B, C, D, etc. These present a higher risk of not getting your promised interest income. In the worst cases, you may also not get your principal back. When interest rates rise, a corporate offering a low-rated bond or deposit will have greater challenges managing its debts. Therefore, it may default on payments. It would be best to exit such instruments at the earliest.
Prepay or Settle Existing Loans
If you’re near the start of your home loan or car loan, your interest outgo will rise considerably for the long term. You can soften this blow by making a principal pre-payment. If you’re approaching the end of your loan, you may be tempted to avoid the increase in interest rates and foreclose it instead of having your tenure lengthened. This is a good option. Alternatively, in case of a home loan, you get tax benefits so if you’re nearing the end of your tenure, you may even want to continue the loan to keep earning tax deductions.
Relook The FD Market
You will start earning higher returns on fixed deposits with rising interest rates. However, for most small depositors, it wouldn’t make sense to break out of old FDs and reinvest in new ones. For example, reinvesting from a 6.5 per cent FD to a 6.75 per cent one will not make a big difference to returns, plus earn a penalty. However, you can consider this option once your gains appear sizeable. But reinvesting from a 6.5 per cent FD to an 8 per cent one will certainly make sense. However, there’s still time before the interest rates reach those heights again.
Get Back To Small Savings Again
Schemes such as the PPF, Sukanya Samriddhi, and NSC are excellent. They are government-backed, allow you to save tax under 80C, and also generate returns in a tax-efficient manner as your returns are not completely taxed. Some of these schemes had become unattractive due to falling interest rates. However, as the rates rise again, they should be reconsidered.
The author is CEO, BankBazaar