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What Is The Impact Of The Rbi Rate Hike On Your Debt Investments?


In a surprise move, the Reserve Bank of India, on May 4, 2022, hiked the repo interest rate by 40 basis points (bp) to 4.4 per cent. 

In response, the yields of the benchmark Indian government bonds with tenure of 2-, 5-, 10- and 14-year inched up by about 32 bp, 37 bp, 26 bp and 22 bp as of 3:25 pm on May 4, 2022, per Edelweiss Mutual Fund’s note on the RBI Monetary Policy Review. 

When yields go up, the bond prices fall, which will result in mark-to-market losses for debt mutual funds. 

“The existing debt fund investors must avoid any knee-jerk reaction at this point in time,” said Vishal Dhawan, CEO and Founder, Plan Ahead Wealth Advisors. He suggested continuing to hold the investments until one’s investment horizon. He also added that “investors in the target maturity funds holding until maturity don’t have to worry as they anyway locked in at the yield at the time of investing.” Target Maturity Funds (TMFs) typically hold the investments till its defined maturity date and after that, distribute maturity proceeds to the investors. 

Fresh investments 

For the fresh investments in the fixed income segment, experts suggest investing in short-term fixed income products. 

Investment in short-term fixed income products including debt funds and fixed deposits will benefit investors in reinvesting the maturity proceeds at a higher interest rate in the future. 

Experts also suggested investing some portion to medium to long-duration funds, if one can hold the investments until maturity. 

Suyash Choudhary, Head – Fixed Income at IDFC Mutual Fund also said “we continue to think that 4 – 5 year sovereign bonds provide very decent duration risk-adjusted return for a medium-term horizon and that investors should continue scaling into this segment over the next few months for those relevant investment horizons.” 

 “With the 5-year government bond yielding close to 7%, as compared to a potential repo rate of 5.5%-6.0%, it is attractive to allocate to bond funds over fixed deposits,” said Pankaj Pathak, Fund Manager – Quantum AMC. 

Note that, in this case, one will be better off staggering their investments instead of making the lumpsum investment. 

Debt funds also score well on the taxation aspect. When invested for over 3 years, these are taxed at 20% after indexation. If held for less than 3 years, the short-term capital gains are taxed at slab rates of the individual. 

Going ahead, bond market participants expect that the RBI raises the repo rate to the pre-pandemic level of 5.15 percent in the next few meetings. Hence, both the existing and the new investors in the debt funds should brace for higher volatility that comes with a hike in interest rates in the short term.

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