The Reserve Bank of India is likely to raise the key policy rate by half a percentage on Friday. According to money market pundits, the RBI is likely to join its counterparts in the US and Europe by hiking rates to tame inflation. Rising interest rate are bad news for the economy and investments as companies may find it difficult to borrow because of higher interest rates. Companies may also postpone borrowing due to subdued demand. What does it mean for your mutual fund investments?
To begin with, the easy money policy is a thing of the past. Thanks to soaring costs of energy and commodities, economies around the globe are dealing with unprecedented inflation. They are also bracing for a recession. Most economies are already dealing with multi-decade high inflation. To tame the runaway inflation, central banks are raising interest rates. The Fed went for another steep hike last week, setting tone for the rest of the world. That is why many money market analysts are predicting a half a percentage hike by the RBI on Friday. Very few players predict a modest hike of 25-35-basis-points hike.
Most mutual fund managers say india is not dealing with many problems of the global economies. Most developed economies were pursuing easy money policies for a while. They were also forced to spend more money during the covid years. India is not dealing with the aftermath of near-zero rates. Sure, India is also feeling the pressure of firm commodity and oil prices, plus outflow of foreign funds. Money market analysts believe the RBI will be forced to hike interest rates in this backdrop.
Now, that you know a rate hike is imminent, let us see how it will impact your investments, especially in mutual funds. A rate hike is always bad news for debt mutual funds, especially long-term debt funds. A rising interest rate regime results in a fall in prices of bonds. This drags down the NAVs of debt schemes. So, expect volatility and lower returns from your debt mutual funds. However, your very short term funds like liquid funds, money market funds, and so on, may offer better returns.
Rising interest rates also have a negative impact on your equity mutual funds. As said before, companies may face higher borrowing costs and subdued demand for goods and services. This would result in them halting or going slow on their expansion plans. This will impair the sentiment in the stock market. So, expect modest returns from your equity mutual funds. If you have investments in high-risk bets, you may also see temporary losses. In short, it is time to be extremely cautious.