How RBI Rate Hike Can Impact Your Investments?

Are you feeling the pinch of price hikes across goods and services? Blame it on inflation which has spiked in the past few months because of rising crude oil prices due to the Russia-Ukraine conflict. Retail inflation measured in India by the Consumer Price Index (CPI) soared to a 17-month high of 6.95% in March 2022. As inflation soars worldwide, some top Central Banks have hiked interest rates to control inflation.

RBI has maintained the repo rate or the benchmark interest rate at 4% and continued with an accommodative stance. It is the tenth time in a row that the Monetary Policy Committee, headed by the RBI Governor, has maintained the status quo to boost the pandemic strained economy. RBI is expected to hike interest rates soon to bring rampaging inflation under control. How will this rate hike impact your investments?

Will RBI hike the repo rate this Financial Year?

Many market experts expect RBI to hike interest rates in June 2022. RBI could increase the repo rate by 50 to 75 basis points in this Financial Year. Moreover, some market experts believe RBI could hike the repo rate by 100-125 basis points (1% – 1.25%) in this fiscal year. 

RBI lends to commercial banks at a rate called the repo rate when there is a shortage of funds. RBI hikes the repo rate to bring inflation down by controlling the money supply in the economy.

Many top banks have anticipated a rate hike and have increased the marginal cost of funds-based lending rates, or MCLR. For instance, SBI has hiked MCLR by ten basis points (0.1%), while Axis Bank, Kotak Mahindra Bank and Bank of Baroda have raised the MCLR by five basis points each across tenures. MCLR is the minimum interest rate for banks and financial institutions to lend. You will have to pay a higher interest rate on home loans, car loans and personal loans if banks hike MCLR rates.

However, while a repo rate hike is bad news for borrowers, it’s good for people investing in bank fixed deposits. Banks have hiked FD interest rates as the RBI may raise the repo rate soon. For example, HDFC Bank has hiked interest rates on FDs of less than Rs 2 crore for selected tenures. Moreover, these new interest rates will be effective from April 06, 2022. Kotak Mahindra Bank has also hiked FD rates of different tenures for amounts below Rs 2 crore.  

How does the RBI rate hike impact mutual fund investments?

A hike in the interest rates impacts rate-sensitive sectors in the economy. For instance, banks, financial institutions, automobile companies and the housing and real estate sector are impacted by rising interest rates in the economy. 

Moreover, these sectors have a high weightage in the stock market indices such as the Nifty 50. The stock markets could steadily go down if the RBI hikes interest rates, impacting returns from equity funds in the short run. 

Equity markets do well when there is ample liquidity. However, if RBI tightens the screws by hiking interest rates, it will result in negative sentiment in the Indian stock markets. Companies will pay a higher interest rate to borrow funds when interest rates rise. Moreover, the US Federal Reserve may consider raising US interest rates by 50 basis points in May, which will impact global stock markets and the Indian stock market. 

What about your debt mutual fund investments? Market experts have recommended that you must not touch your existing debt funds as interest rates could rise soon. However, you can focus on deploying incremental amounts slowly in certain debt funds.

Rising interest rates mean debt-oriented funds risk a fall in price as bond prices are inversely related to yields. A fall in bond prices pushes down the Net Asset Value of these funds.

Interest rate hikes negatively impact debt funds of longer duration, such as long duration funds. However, you can continue to invest in short duration funds that can offer higher interest income. It is a debt fund that invests its assets in debt securities and money market instruments with a Macaulay duration of one to three years. 

You must pick suitable mutual funds based on risk tolerance to achieve your financial goals. In a nutshell, choose appropriate equity and debt funds that perform well when interest rates are about to go up. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in