The Hindu Business Line : Spotlight on rising interest rates

`Grin and bear it' is the message for investors now. Rising interest rates could trip the equity market rally. Long-term investors, though, need not be sidetracked. Debt and equity investments will still yield enough to build wealth and beat inflation.

Liquidity constraints
Liquidity constraints are growing
Interest rates could keep rising
Equity and debt prices will fall as rates rise
Long-term investment still makes sense

It is that time of the year when worries about interest rates routinely start surfacing. It is that period when interest rates start rising as they threaten to do even this year.

Observers start warning about the possible implications for your portfolio as rising interest rates, in the short-term, can drag down prices of equity, debt and perhaps even real estate. It is, however, clear that retail investors can do nothing much except focus on the long term and temper the return expectations.

Ides of March

Ides means `to divide', and March has typically divided the calendar into rising and falling phases for the equity market; the preceding half generally seeing a spurt in prices. The month has in the past occasioned a fall in the prices of debt instruments as the government's borrowing programme proposed in the Budget spooks investors.

History apart, the capital market is now entering a tricky phase. This time several factors are conspiring to push interest rates up. Principally, banks are unable to mobilise enough resources to meet the growing demand for credit. Until this year, they have sold government securities and lent that money to borrowers. They may not be able to do that the coming year. Intense pressure on liquidity is thus expected, calling for dramatic interventions from the Reserve Bank of India.

This could have implications for both the equity and debt markets. For equities, growth impulses in the economy are strong as ever. Valuation levels, though, have factored in almost all the possible upside.

Any setback on the earnings growth front because of rising interest rates will not send the house of cards collapsing. It could, however, mean a decline in stock prices of 10-15 per cent.

The decline in liquidity could worsen the situation. Research shows that rising interest rates also impact stock price fluctuations.

Again, rising interest rates will inflict damage on debt instruments. As pressure on liquidity appears to be rising sharply, even investors in term deposits will feel the pinch.

If they invested today at 7 per cent for five years, they could find the rates scurrying up to 8 per cent six months from now. Borrowing rates have risen and could go up further.

This could moderate the demand for real estate.

Beating the odds

Given the interest rate scare, it would be tempting to liquidate all assets and invest in savings bank and money market funds. That, however, would be an irrational response.

There is actually nothing much that you can do expect stay invested. Many successful investors have often indicated that the ability to ride the down market is what will help investors make money. If you invest at 10,500 and chicken out at 10,000 then investing will never appear attractive to you.

If your investment horizon is five years or more, you need not be sidetracked by the growing concern on the interest rate front. Over the long term, the objective is to beat inflation and, irrespective of whether you are investing in debt, equity or real estate, gain returns that are higher than the prevailing yield on government securities. That is still possible.

For retail investors who lack the skill to manage their investments, mutual funds — both equity and debt — would come in handy. For investors aspiring for two-digit returns from the capital market in the short term, the next 12 months could prove disappointing.

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