“On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting today (June 8, 2022) decided to:
• Increase the policy repo rate under the liquidity adjustment facility (LAF) by 50 basis points to 4.90 per cent with immediate effect. Consequently, the standing deposit facility (SDF) rate stands adjusted to 4.65 per cent and the marginal standing facility (MSF) rate and the Bank Rate to 5.15 per cent.
• The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. These decisions are in consonance with the objective of achieving the medium term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth,” said the RBI governor.
“The policy was mostly in line with market expectations. It was graded and they did not increase the CRR which is positive. Inflation has gone up 100bps from forecast wise, which means RBI is going to continue front-loading rate hikes. I think the RBI would want to take the repo rate at least to 6% by next year, it is at 4.90% right now. Pre pandemic levels were 5.15%. Which means progressively at least 25 bps hike in every policy meet in this year,” says Lakhsmi Iyer, President and Chief Investment Officer (Debt) & Head Products,
With today’s hike, the central bank is clearly indicating that interest rates are going up and they are likely to stay higher sometime. That means your debt mutual funds are likely to be hit. Long term debt funds are likely to lose money in a rising rate environment. Sure, short term debt funds may recover in a while. But be prepared for higher interest rates.
“The 50 bps rate hike was factored in by the market, so I don’t see it disrupting the market as such. I think RBI will continue to increase rates in this year to reach at least 6.75% till next financial year. I don’t think there will be any change in the market after today’s announcement, maybe a small relief rally. Yields have been going up but the policy will not trigger it further, much of the yield curve is already discounted. There is a risk from the global economic uncertainty, Fed’s hawkish tone and geopolitical situations pushing crude oil prices up. The debt market will remain volatile till these things are stabilized,” says Pankaj Pathak, Fund manager, Quantum Mutual Fund.
Sure, bank deposits may offer you a slightly better interest rate. However, you will have to pay taxes at the application income tax slab. So, it makes sense to invest in debt mutual funds, especially if you have a large investment portfolio. Debt mutual funds are taxed at 20% with indexation if you hold the money for more than three years. If you are investing for less than three years, they don’t have any tax advantages. They are taxed like bank deposits at applicable income tax rates.
Mutual fund managers believe that investors who want to invest in bond funds should have at least three years. If you are a conservative investor, these managers believe you should stick to liquid and ultra short term funds.
“If you have three years or more, dynamic bond funds are very well positioned at the moment. You can play the rate hike with these schemes. The flexibility to change duration with every rate hike can be beneficial,” says Pankaj Pathak.
Lakshmi Iyer believes that if an investors wants to take a little risk and has a long term horizon, one can invest in medium duration funds as well, but mind the volatility. “You can invest in medium duration funds if you have a longer term horizon. If you don’t want to take risk, you can explore target maturity bond funds,” suggests Lakshmi Iyer.
If you are investing for three years or more, you may invest in banking & PSU funds and corporate bond funds. For very short term needs, you can use liquid funds, ultra short term funds, money market funds, among others. As said before, long term debt funds, including gilt funds, are likely to face trying times. So be prepared to face volatility and possible short- term losses. Only if you have a long term investment horizon and prepares face volatility, invest in them.