With a sustained double-digit WPI inflation (wholesale price index) for over 12 months and the CPI inflation (consumer price index) crossing the RBI target for the last three consecutive months, the Reserve Bank of India (RBI) couldn’t continue with its accomodative policy stance anymore and has decided to hike the repo rate by 40 basis points to 4.4 per cent and the Cash Reserve Ratio (CRR) by 50 basis points to 4.5 per cent.
Focus on inflation
The decision of the RBI Monetary Policy Committee (MPC) in an off-cycle meet would help in fighting the relentless rise in inflation, even as the rate hike may increase borrowing cost for industry.
The decision is in line with the US Federal Reserve’s preference to control inflation over the impetus on economic growth, the onus of which will now fall on the government.
No benefit for existing investors
While the rate hike would provide the fixed-income investors a higher rate of interest on fresh investments, the existing investors having their money locked in low-interest instruments for a long term would suffer.
This is because holding the existing investments would fetch them lower return for the remaining investment period and redeeming the existing investments would result in capital loss for them.
“RBI rate hike has led to 5 Years and 10 Years Gsec yields going up by 25 bps and 20 bps respectively, which resulted in accumulation of negative MTM for existing fixed income investors following long duration strategies,” said Purav Radia, AVP – Treasury Solutions at IFA Global and Treasury Elite – Treasury & Wealth Management Solutions.
Good for new investors
The rate hike to fight high inflation rate would ensure higher rate of interest for new investors, which would help them in countering the price rise.
“New investors having appetite to hold till maturity may earn extra yield to the tune of 50 to 150 bps over PSU Bank’s FD returns depending on the curve by investing in Gsecs as deposit rates have not increased in a linear fashion as compared to pick up in yields in the last few months,” said Radia.
While the higher rate of interest would provide an edge to the new investors in countering the high rate of inflation, the tax on interest earned from the investments in instruments like fixed deposit (FD), taxable bonds etc would still be a drawback.
So, the investors need to focus on tax efficient investment avenues to ensure that tax doesn’t eat up a portion of the higher return.
“Investors going for 3 year plus maturity should go for the mutual fund (MF) route to capture indexation tax benefits and short term investors should look at direct Gsecs investments,” said Radia.