Lower Interest Rate Cycle – Are You Ready for these 5 Changes

Lower Interest Rate is an alien concept for India. Typically, India as a country is “high interest rate” country. The reason being we are Savers rather Spenders. Because of this reason, we expect “high” interest rate on Savings and willing to pay “higher” interest rate on Loans. As i shared in my previous posts, the saving rate in India is one of the highest in the world i.e. 30%. In my post, Small Savings Schemes i explained how a cut in interest rates will help consumption cycle. Basically, the objective is to reduce savings and increase spending.

The interest rate in growth-oriented economies like the USA is near zero. On the other hand, our REPO rate is 6.5%. Based on recent indicators especially bond yields, we can conclude that we are moving towards lower interest rate cycle. The borrowers, markets, FII’s, Banks, investors etc everyone seems to be quite excited about the lower interest rate in future.

The lower interest rate will be good news for spenders but bad news for savers. As a borrower i will be more than happy as my interest rate on various loans like Home Loan, Auto Loan, Personal Loan etc will reduce. Paradoxically, i want lower interest rate for my loan but at the time would not like to compromise on the interest rate on savings i.e. FD, Small Savings Schemes etc. In other words, i expect my home loan interest rate to be 5% and fixed deposit interest rate to be 10%. To be very frank, It is not possible. Life is a zero-sum game, the gain is neutralized by loss somewhere.

The global economy is going through a rough patch as i shared in my recent posts. The experts are of the opinion that in order to maintain the growth of 7% plus, we (India) don’t have any choice but to lower interest rate. Globally, large economies are already near zero interest rate. Quite shockingly, the govt bond yields of Japan and Germany are negative.

Sooner or later, RBI will take an aggressive stance on REPO Rate and experts are expecting a sharp cut in interest rates. The picture looks quite bright and colorful in the case we fully enter lower interest rate cycle. From a personal finance perspective, it will be a major shift for individual investors. Therefore, it is important to be future-ready. I am highlighting some of the changes that an individual will observe in the coming months. I will also mention some of the steps to safeguard your personal and financial interests.

Lower Interest Rate Cycle – Are You Ready for these 5 Changes

1. Lower Return on Investments:

In my opinion, the days of double-digit returns are over. Here i am referring to net returns from diversified investments. The investors have to readjust their expectations. Though it is hard to digest. Recently, there was a news report that Govt is mulling an idea to reduce the interest rate on a savings account that is currently capped at 4%. Any reduction in same will reduce the cost of funds for banks and boost the chances of lower interest rate.

One of the most popular investment options in India is Small Savings Schemes like PPF, Sukanya Samriddhi Account etc. From 1st April 2016, the interest rate on small savings schemes will be revised every quarter. The reason for the cut in interest rates of small savings schemes is because of their competition with bank FD’s. The lower interest rate cycle is only possible if the interest rates of both bank FD’s and Small Savings  Schemes are reduced. Otherwise, one option looks better compared to other. The investor will keep circulating money between bank FD and Small Savings Schemes thus interest rates will never come down. In other words, investors should not have any incentive to SAVE.

Current returns from the property are either negative or stagnant. On the other hand, the returns from equity are marketed/projected at 10%-12% in a long run. Always remember that it is a pure marketing gimmick. These returns are projected based on the assumption that you will be investing in best performing funds. Trust me it cannot happen. The best performer of today might be laggard of tomorrow. The stock market is a very dynamic place. It follows the policy of pumping and dumping. Therefore, there are NO CLEAR WINNERS. The Gold as an asset class i already discussed in my earlier posts.

The no. of investment options with high return on investments are squeezing and investors will need bulls eye to identify the same. I will discuss it in Point no 5.

2. Jobless Growth

The salaried class is under the misconception that lower interest rate will boost growth. In turn, growth will create more no of jobs. If we take a cue from other economies and listen to experts, the lower interest rate will usher jobless growth. Automation is key to survival in future for Indian Inc. I have already highlighted it in my post, Jobs that are in danger.

We should be ready for jobless growth and embrace the new retirement age of 40 years. The organizations need young blood. In the new age sectors like e-commerce or sectors undergoing a technological transformation like banking, IT etc. the organizations don’t need experienced employees. The value/premium of “job experience” is almost OVER.

3. Reset and Revise Financial Goals:

Financial Goals are based on certain assumptions. For example, if i am investing in PPF for 15 years with an assumption of 8.75% interest rate for my child’s marriage. Now because of lower interest rate cycle, the interest rate may reduce to 7.5%. In this scenario, i need to reset and revise my financial goals. Either i have to increase my investment amount or find out some other investment option with 8.75% interest rate to achieve a financial goal.

It is not an easy task as it looks. The reason being, as i mentioned that no. of investment options with the return of 8.75% will also shrink under lower interest rate cycle or you may not find any without high RISK.

4. Borrowing Cost:

The overall borrowing cost will reduce. In other words, my interest outflow will decrease. It will increase the affordability i.e. loan eligibility will increase. Prima facie, it will be beneficial for the borrowers. It is good for sectors like Real Estate, Automobile, Consumer Goods etc.

The higher affordability means more borrowing/purchasing power. As a smart investor, you should borrow only to create assets that are appreciating in nature. A learning from western countries is that lower interest rate means debt trap. You should not borrow beyond your means. Lower interest rate cycle will not remain forever. When the cycle will reverse, a borrower may find it difficult to repay the loan. He might not be able to service the loan. The end result is a debt crisis.

As a thumb rule, even if i get a loan at lower interest rate, i will not avail for the purchase of depreciating assets like 2 wheeler, car, TV etc. A loan can be availed only for appreciating assets e.g. property.

5. Diversified Investment Portfolio will be Dead

Basically, an investment portfolio is diversified to hedge risk. I will be more than happy to diversify if there is a hope/scope of double-digit returns. In lower interest rate cycle, you cannot expect double digit returns with the diversified portfolio as i explained in point no 1.

We need to change our investment style and take more risks. Again i will quote investment pattern of western countries. The investments are more focused towards a couple of asset classes, unlike India. In India, experts suggest investments in 5-6 options. Another reason for diversification in India is financial illiteracy. Even after the greater degree of diversification, double-digit returns are still a mirage for many Indians.

If i consider myself as an investor then i will bet only on 2 financial products i.e. Gold and Long Term Debt Funds. I have explained the reasons in my detailed posts on these topics. The reason for betting on Gold is turmoil in the global economy. Whereas Long Term Debt Funds will be a natural beneficiary of lower interest rate because of low bond yield. To put it differently, if i am risk averse then i will invest in long term debt funds. On the other hand, investors with a high-risk appetite can invest in Gold. They can expect a doubling of their investments in next two years.

Summary:

There are exciting times ahead. The learnings of past may not hold true. For example, traditionally Interest rate and inflation move in the same direction i.e. lower inflation means lower interest rate. Currently, inflation is increasing and interest rates are decreasing. Therefore, past learning is void.

On the other hand, dollar and Gold prices move in inverse direction i.e. strong dollar means lower gold prices. Currently, the dollar is strong and Gold prices are also increasing. On top of it, Stock Market is also moving up. Honestly, experts are also confused with these contradictory movements. These movements show that global economy is heading towards the financial crisis.

There is a common consensus worldwide that interest rates will soften further and India is not an exception. To push growth, Govt will push for lower interest rate. I have fine tuned my investment strategy accordingly. Therefore, be ready for lower interest rate cycle.

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