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RBI Rate Cut: How to Realign Your Investments

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RBI Rate Cut: How to Realign Your Investments

The surprise rate cut from the Reserve Bank of India on Thursday spells good news for borrowers who may expect their EMIs to fall. In fact, a few banks have already announced a cut in their base rates.

But for bank depositors, a falling interest scenario suggests that banks are also likely to cut their fixed deposit rates. This will hurt the interest income of those investing in bank deposits.

Arundhati Bhattacharya, chairman of State Bank of India, said, "We believe that this RBI cut may be just the beginning of a rate easing cycle... Base rate is expected to fall faster than expected."

Mahesh Nandurkar, executive director at CLSA, says banks are likely cut deposit rates as the credit demand remains weak. Besides, falling commodity prices will reduce the demand for working capital from corporates and banks would have adequate liquidity, he added.

Mr Nandurkar sees the RBI cutting its policy rate by 50 bps to 100 bps this year and banks cutting their lending rates even by more due to weak credit offtake.

What should an investor do who wants to put money in bank fixed deposits? Invest for the long term, says Mumbai-based planner Suresh Sadagopan, who is the founder of Ladder 7 Financial Advisories firm. Investing in longer-tenure bank fixed deposits helps in locking higher rates, he added.

Mr Sadagopan also suggests that investors with a slightly higher risk appetite can also look at fixed income or bond mutual funds. Mutual funds investing in longer-term debt securities look particularly attractive, he added.

Mr Sadagopan says investors in long-term bond funds can expect double-digit returns annually in the medium term.

The price of fixed income securities like bonds is inversely proportional to interest rates. This means that when interest rates fall the price of the securities go up and thus the net asset values (NAV) of mutual funds.

The intermediate bond funds have given an average return of 9-10 per cent in the last six months, according to Morningstar data, as bond yield on 10-year government bonds fell from 8.5 per cent levels to the current levels of 7.75 per cent on expectations of RBI rate cuts.

Investors who don't want to actively take a call when to invest in long-term bond funds and when to exit can opt for dynamic bond funds. A Balasubramanian, CEO of Birla Sun Life Asset Management Company, suggests investors to invest in dynamic debt bond funds in which fund managers actively shuffle the bond portfolio to take advantage of emerging opportunities.

The tax advantage of debt mutual funds as compared to bank fixed deposits also increases their attractiveness.

Tax Treatment

Debt mutual funds score over fixed deposits in terms of their taxation. Investors can claim indexation benefit on debt mutual fund schemes after three years, significantly lowering their tax outgo on the gains. On the other hand, the interest on fixed deposits is fully taxable. It is added to the income of the investor and taxed as normal income.

Disclaimer: "Investors are advised to make their own assessment before acting on the information."

 



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