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In its efforts to tame inflation, the Reserve Bank of India hiked the repo rate yet again—by 50 basis points on 30 September. After four consecutive hikes, the repo rate has gone up from 4% in April to 5.9%. Here’s what higher rates could mean for investors and borrowers:
Should you break your fixed deposits and reinvest in a higher yielding one?
Not quite. In the past, hikes in FD rates have generally lagged repo rate hikes. For example, while the repo rate has gone up by 190 bps since April, banks have hiked their 1-2-year deposit rates by only 20 -150 bps over this period , as per Bankbazaar data. Also, premature termination of an FD comes with a penalty. Going forward this may, however, play out differently. According to Anil Gupta, senior vice president & co-group head – financial sector ratings, ICRA, with strong credit growth, and liquidity in the banking system getting squeezed, retail bank deposit rates are expected to go up. Given this, and further expected rate hikes, investors can continue with their FDs.
Should you invest in an FD or a debt mutual fund?
Debt mutual funds can be better. Since unlike FD rates that may go up only with a lag during a rate hike period, bond yields react faster to rate changes. In fact, very often bond yields move up even before the actual rate hike happens.. They score over FDs on taxation too. Your returns from a debt fund (if sold after being held for over 3 years) are taxed at 20% plus 4 % cess after indexation benefit. But FD interest income is taxed at your tax slab rate plus 4% cess, making it prohibitive for those in higher tax brackets.
The g-sec yield curve has flattened (higher tenure bonds are offering yields similar to shorter tenure ones). Hence, rewards for investing in long duration funds are limited.
According to Mahendra Jajoo, CIO- fixed income, Mirae Asset Investment Managers (India), for those who have a longer-term horizon and can take interim volatility, 5-year target maturity funds are a good option to lock-in bond yields.
Should you prepay your home loan?
While prepaying may seem an obvious choice, you also lose out on home loan interest deduction. “You can instead use your surplus funds for investing in alternate products,” says Gupta. Home loan interest deduction has an upper limit of ₹2 lakh per FY. If your interest exceeds ₹2 lakh, the prepayment makes sense.
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