While the current market scenario boasts of fluctuating interest rates, the Reserve Bank of India has increased the key policy rates by 50 basis points with immediate effect, so as to attempt to bring inflation to a halt. While inflation is determined by the three integral factors of the state of the global economy, the health of the Indian economy, and their influence on the growth of the Indian economy, it is advisable to analyze each of the factors independently, so as to understand their contributions to the rate of inflation in the region. While globally, markets have faced a downturn due to the influence of the liquidity crisis and the sovereign default, even a slight increase in the rate of these aspects will in turn increase the risk aversion of markets worldwide. On the other hand, a rise in the prices of commodities can also lead to a global inflation. If a global turmoil in this regard can be expected, then domestic growth will come under intense pressure, thereby leading to a control on inflation. This will subsequently, provide the perfect setting to push interest rates down.
Keeping the current macro-economic sentiment in mind, interest rates are not expected to rise steeply; although there isn’t any assurance that interest rate will fall too. Thus, investors in fixed deposits are advised to invest in deposits with a long-term maturity period. This is because an investor who has invested in fixed deposits for a period of one year will be charged with rates that are higher by as much as 50 basis points than the rates that will be charged over and above 3-5 year fixed deposits. However, if the rates fall within the next 12 or 15 months, investors may have to face a risk of having to reinvest their proceeds of their one year fixed deposits at comparatively much lower rates. It is thus a better decision to invest in debt mutual funds, keeping the tax benefits offered in mind. It is best advised for you to not opt for loans as of now and try to link your financial requirements to your investments and wait till they mature. A loan will increase the financial burden and may not give you fruitful returns on your investments.
When the interest rate cycle spirals downwards, gilt funds serve a profitable option to investors as they possess longer periods of maturities. These funds primarily make investments in government securities, with little or no possibility of default. Investors can also enjoy the benefit of capital appreciation when the interest rates fall. However, if fund managers seek to invest in bonds that offer higher maturity, it may lead to volatility in the near future in case the yields of the fund rise. If you want to make an investment in mutual funds, without indulging in any form of risk with your fixed income portfolio, then do not hesitate to make an investment in short-term bond funds. These can help you generate good post-tax returns over a period of the next 1-2 years. You can also choose to invest in short-term gilt funds, in order to completely do away with the concept of default risk. An investor can also seek to make an investment in liquid plus funds for a short period of time, in order to benefit from the strong money market rates, who can then take a proactive decision of shifting to short-term bonds.
Non-convertible debentures are also a good option for investment, as they provide high returns against lower ratings, thereby indicating a higher amount of risk as compared to a corporate fixed deposit. If you are willing to take the risk, then consider non-convertible debentures with a five-year horizon, so as to bag a higher coupon rate and greater capital appreciation, before the maturity rates decline. Prior to making an investment in these tools, it is important to remember that these debentures are listed products of the stock exchange may therefore, not be liquid instruments. Thus, an investor must be willing to hold on to these instruments until the period of maturity does not arrive.