MONETARY POLICY

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The monetary policy confirms fears of a higher inflation and modest rise in interest rates.

First, good news for the yuppies. The interest rates are staying where they are. At least, for the time being. So, go for your housing and consumer loans as soon as possible. Now, bad news for the retired people. Sorry, the Reserve Bank of India has refused heed to your prayers. You are not going to earn extra percentage on your deposits. Also, be prepared to tighten the belts further. The central bank expects the inflation to rule high for the next six months. Well, that sums up Reserve Bank of India’s mid-term monetary policy for individuals.

If you are wondering what this hullabaloo all about, here it is. The Reserve Bank of India announced its mid-term monetary and credit policy for the year 2004-05 on October 26. The annual policy is an assessment of the performance of the economy and it also spells out projections about its future course. Bankers, industrialists, markets, etc. take a cue from this semi-annual policy statement. This year’s policy among other things had two factors, which will have an impact on your daily lives as well as your savings and investments.

For the first time, after a gap of five-year soft interest rate cycle, the central bank has revised its annual interest rate forecast to 6.5% from 5%. The apex bank has also raised Repo rate, the rate at which banks lend their surplus funds to RBI, to 4.75% from 4.50%. These measures confirm fears that inflation is going to stay here and short-term interest rates are likely to go up a tad in the near future.

Now, let us get to the basics. Is inflation going to get out of hand? “At the moment the government can’t do much about inflation as it is mostly due to a spurt in prices in oil and commodity prices,” says a fixed income analyst. “It is doing everything possible, like duty cuts, to make sure that inflation doesn’t get under control.” According to market players, the inflation should abate once the oil and metal prices come down in the international market. In addition, when it will happen is anyone’s guess. However, expect the inflation rate to hover around 7% in the next few months.

What does that means to interest rates in the economy? Are we going to see any steep revision in interest rates? “It is unlikely,” says the analyst. “The new government doesn’t want to see the rates up drastically. Even RBI doesn’t want that to happen because it may stifle growth in the economy.” That means that deposit rates are not likely to see any significant increase in the near future. Interest rates on selective areas like credit card, housing loan, personal loan, etc. may see a jump in rates.

In the policy, the central bank has noted the robust growth in housing and consumer credit. As a temporary ‘counter cyclical’ measure, it has proposed to increase ‘risk weight from 50% to 75% in the case of housing loans and from 100% to 125% in the case of consumer credit including personal loans and credit cards.’

 According to observers, this could push up rates for these loans. Moreover, even the rise in yield on government securities market, which forms the benchmark for these loans, also point towards this direction. Though bankers dismiss the talk of a rate hike, many believe that it is imminent. “There should be a hike in housing loans at least by 50 basis points in a month or two,” says an official with public sector bank. “Everybody is reviewing the situation. The rates would have gone up already if it was not for the stiff competition,” he added.

Let us move to your investments. First, what the credit policy spells for debt fund investors, who forms the majority of the investing community in the country. “Investors will be better off in short term funds,” says Rajan Mehta, executive director, Benchmark mutual fund. “Medium and long term funds are likely to see a lot of volatility. Investors would be better off in a 8% RBI bond during these times of uncertainty, he adds.”

“Investors should concentrate on short-term funds, money market mutual funds, floating rate funds, etc. as these funds will be less affected by the volatility in the market. Next few moths are likely to be really volatile,” says Nandkumar Surti, head, fixed income, JM mutual fund. “However, if you are long-term investor, who understand the risk in debt funds, there is nothing wrong in investing in an income fund with, say, one-year horizon,” he adds.

Now, let us move to equity investments. The RBI has revised its GDP growth forecast to 6.0-6.5% against the earlier 6.5-7.0%. A slowdown in GDP along with costlier funds can eat into the profits of companies. Will that reflect on the gains in the stock market, too? “The credit policy doesn’t alter the scenario in the market drastically. Also, the cost of funds are not likely to go up significantly to affect bottomlines of companies,” says Rajiv Thakkar, head of research, Parag Parikh Financial Services. His only word of advice: select the stocks carefully. “It is going to be companies, not the entire market or sectors, which will give good returns.”

Snapshot

Proposals What it means?
Bank Rate unchanged at 6% Medium, long term rates likely to be steady
Repo rate up by 25 bps short-term interest rates likely to go up
Risk weight up on home and personal loans Home, credit card, personal loans cost more
Direct finance to housing sector raised to Rs 15 lakhs under priority sector status Fillips to small and medium sized home loans
Minimum tenure for term deposit reduced You can park your surplus funds in banks to 7 days instead of liquid funds

 

What it means for your kitty

  • Inflation likely to rule high
  • No immediate hike in deposit rates
  • Interest rate in on credit card, personal loans likely to go up
  • Home loan rate may go up shortly
  • Debut funds, especially the medium and long term, becomes unattractive
  • Equity continues to be good investment

 

 

 
 

 

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