How the rising interest rate will affect you?
The interest rate upcycle has started with the RBI raising the Repo rate by 40bps and CRR by 50bps. Similarly, the US Fed also raised the benchmark short-term rate by 50bps.
However, the recent rate hike was not unexpected, because of geopolitical tensions, increasing commodity prices, and rising inflation. The market participants had already expected the rate hike. The yields on the government securities have been steadily rising in the last couple of months.
What are Repo Rate and CRR?
Repo rate (Repurchasing Option Rate) is the rate at which the Central bank of the country lends money to the commercial banks.
The cash reserve ratio (CRR) is the percentage of total deposits that a bank needs to maintain with the Central bank of the country.
Thus, if the Central bank increases the Repo rate, then it would increase the cost of funds for the commercial banks and it would increase the loan interest rates.
And if the Central bank increases the CRR, then it would reduce the cash in hand with banks and it would decrease the liquidity in the economy.
What are the effects of rising interest rates?
The cost of funds and the cost of deposits are likely to increase for the banks. In India, the 10-year bond yield has already increased to 7.5 percent. Rate hikes by central banks worldwide can check the inflation but could also hurt growth.
This would be a double whammy for some companies, because of rising input costs and rising interest rates. The rising interest rates can affect consumer demand, especially for the consumer durables and discretionary items.
For individuals, the loan EMIs of housing loans, auto loans, student loans, etc. will increase.
Is it good news when the interest rate is rising?
To some extent, it is good news for the retail investors and senior citizens who were struggling with the low yields on savings and fixed deposits. The interest rate on bank deposits is also likely to increase over a period.
What to do when the interest rate is rising?
Bonds and Fixed Income investors
The initial ride would be bumpy for the investors in bonds or fixed-income securities. There might be a loss of capital in the medium term because of the rising yields.
Allocating funds to ultra-short debt funds and floating-rate debt fund is better for Short-term investments.
For Long-term investments, invest in bonds and debt funds in a staggered manner and increase the allocation with every rate hike in the future.
And for the Medium-term investments, target maturity funds, fixed deposits, or good credit quality corporate bonds are better options.
Equity Share investors
The rising interest rates will affect share price valuation as it can affect the corporate earnings. Current expectations are for a further 75-100 basis point hike in the current financial year. The volatility may also remain high in the medium term.
In the current scenario, consider investing in low volatility and high dividend-paying stocks in a staggered manner. Read our blog, What’s Next for Nifty here.
You can do the screening with two indices; the Nifty Low Volatility 50 Index and the Nifty dividend opportunities 50 Index to identify the low volatility and high dividend-paying shares.
Nifty Low Volatility 50 Index
The Nifty Low Volatility 50 Index tracks the performance of the low volatile companies in the large market cap segment. Some companies tracked in this Index are Asian Paints, Bata, Cipla, Divi’s Lab, Exide, HDFC Bank, Hero Motors, HUL, ITC, Indian Oil, Infosys, L&T, Lupin, NTPC, Page Industries, Petronet LNG, Pidilite, Power Grid Corporation, TCS, etc.
Nifty Dividend Opportunities 50 Index
Nifty dividend opportunities 50 Index tracks the performance of high-yielding companies. Some companies tracked in this Index are BPCL, HPCL, HUL, Britannia, CESC, Chambal Fertilizers, Coal India, Cummins, GAIL, Hindustan Zinc, ITC, IOC, NMDC, NTPC, Nestle, ONGC, Power Finance Corporation, Power Grid, REC, Tata Steel, Torrent Power, etc.
There are many companies that make the cut in both the Nifty Low Volatility Index and Nifty dividend opportunities Index. Some of such companies are Britannia, Colgate Palmolive, Hero Motors, HUL, IOC, Infosys, ITC, L&T, Mahanagar Gas, Nestle, NTPC, Petro net LNG, Power Grid, TCS, etc.
Above are general guidelines and not a recommendation to buy a specific fund or an equity share. Do your own homework before investing.
Moderate your expectations because of the present circumstances relating to the global downturn, rising interest rates, and geopolitical issues. The double-digit returns in shares may not come in the medium term. Continue to invest in a disciplined way and protect your capital, as you cannot force the market to give a specific rate of return.
This article is only for educational purposes and is not investment advice. Please consult with your investment advisor before investing.