By Hemanth Gorur
As borrowers cheer for falling interest rates, bond investors and term deposit takers are wringing their hands in desperation. Investors who depend on fixed income securities have seen their interest income decline in the recent past. This may persist for a while, but all is not lost for bond investors. Knowing the evolution of interest rates in the market and the alternative investment products available can help you get through these tough times smartly.
Interest rates that matter
The history of interest rates begins with the RBI annuity rate. The repo rate is the rate at which the RBI lends to all other banks. Retail bank lending rates are directly linked to the repo rate. Currently, banks quote a âspreadâ above the repo rate, giving the loan rate linked to the repo rate (RLLR).
On the deposit side, any bank’s interest rates are typically 2-3 percentage points lower than that bank’s corresponding lending rates. Interest rates on deposits and interest rates on loans tend to move synchronously, but the former fall faster and rise more slowly, while the reverse is true for the latter.
Finally, bond interest rates are the coupon rate that is guaranteed to be paid to the bond investor. When interest rates fall in the market, bond prices rise because bonds are in more demand than deposits, but the interest rates on bonds already purchased are not affected.
Current rate trends in the market
The repo rate is currently at an all-time low of 4%. The repo rate is expected to stay in the 4-5% range for some time, given the prevailing macroeconomic scenario.
Likewise, bank loan rates have also moved south. According to RBI data, weighted average lending rates (WALRs) on existing and new loans at banks have fallen steadily over the past nine years. While the former has fallen from around 12% to around 8% during this time, the latter has fallen from around 12% to around 6%.
Deposit rates also exhibited a similar behavior, with the Weighted Average National Term Deposit Rates (WADTDR) falling from around 9% eight years back to around 5% currently. As long as the repo rate stays within the aforementioned range, deposit rates and bond interest rates are likely to remain subdued at current levels for a year or two.
What can bond investors do?
This brings us to what bond investors need to do. Investors who have already bought bonds would likely have coupon rates higher than prevailing market rates, in which case they would have to end the bond’s term to maturity and not exit prematurely.
Investors looking to invest in bonds should choose bonds with shorter maturities. This is because you don’t want to lock yourself into a low interest rate for a longer period of time when interest rates are likely to rise once macro signals allow. Alternatively, investors can also opt for floating rate bonds, market linked debentures or floating funds, where interest rates would increase with prevailing market rates. As interest rates have bottomed out, there is little or no risk of them falling further from current levels.
Bond markets are not as volatile as stock markets, so take the time to do your due diligence and make an informed decision.
The writer is founder, Hermoneytalks.com