How to benefit as interest rates fall

After a long wait, it is finally here – a downturn in interest rates. The Reserve Bank of India (RBI), after raising its policy rates from 4.75 per cent to 8.5 per cent over 2010-11, began to take its foot off the pedal last year. Since April 2012, rates have declined from 8.5 to 7.25 per cent. But if you expected these rate cuts to significantly help borrowers and trim deposit rates, it hasn’t played out exactly that way.

These trends in interest rates have a two-fold impact on retail investors.

Limited EMI savings

Higher policy rates translate into higher interest rates on all the loans that borrowers take on a floating rate basis. Therefore, when rates move up, there is a spike in equated monthly instalments (EMIs) for home loans.

In July 2010 the base rate for SBI, the rate to which all its lending rates are linked, stood at 7.5 per cent. A floating rate home loan taken then, with a mark up of 1 per cent, would have carried an interest rate of 8.5 per cent. With RBI raising repo rates, SBI’s base rate went up to 10 per cent by August 2011 and the rate on your home loan would have moved up to 11 per cent. Let us say you took a home loan for Rs 40 lakh for 15 years. The steep increase in rates would have meant a Rs 6,074 spike in your EMI from Rs 39,390 to Rs 45,460, a 15 per cent increase.

The recent cuts in policy rates, however, have been smaller and, what is more, have also not been mirrored by lending rates. While RBI has reduced rates three times by a total of 125 basis points in the last one year, banks’ base rates have fallen only by 30-50 basis points. Banks’ have been unable to immediately reduce loan rates because they have continued to pay higher interest on their deposits.

As a result, borrowers have reaped limited savings from recent rate cuts. SBI’s current base rate is 9.7 per cent, 30 basis points lower from last year. In the example quoted above, as a borrower, your EMI would have come down to Rs 44,710, just a Rs 750 saving per month. While rates for older borrowers have not fallen much, intense competition in the home loan market has brought down rates more sharply for new home loan takers. SBI has, for instance, cut its new home loan interest rate by 60 basis points. A good way for borrowers to take advantage of this anomaly is to switch their loans to a new lender, who may offer better rates.

Depositors in the pink

But if lending rates have not dropped drastically, that is good news for depositors, because they have enjoyed higher returns on their money parked with banks. Deposit rates offered by banks for terms of over 1 year rose from 6.75-7.75 per cent to 8.5-9.25 per cent between mid 2010 and March 2012. This translates into an additional Rs 1500 per annum as interest, for every Rs 1 lakh of term deposits made. But deposit rates have not fallen sharply with RBI’s recent rate cuts. Thanks to the liquidity crunch, banks continue to scramble for deposits, keeping their rates high. The average term deposit rates declined only 10-20 basis points during 2012-13.

With liquidity continuing to be tight for banks, deposit rates are likely to fall more slowly than market interest rates in the next few months. This is a good opportunity for you to lock your surplus funds into 3-5 year term deposits at prevailing rates.

India Inc yet to gain

If the recent fall in interest rates has left depositors better off and borrowers worse off, what about India Inc? Well, companies are yet to reap any significant benefits from recent rate cuts, numbers show.

Data for BSE 500 companies (excluding banks and financial institutions) shows that while their sales grew 22 per cent in 2011-12, their net profits declined 4 per cent. This was partly due to a spike in interest expense by 43 per cent during 2011-12. The interest cost as per cent of sales increased from 1.8 per cent to 2.4 per cent during this period. Particularly hit were sectors such as steel, construction, power generation, infrastructure, textile and realty that are heavily indebted.

Even as rates began to fall in 2012-13, companies have not seen a boost to their profits. With the slowdown, sales growth for the BSE 500 companies slowed substantially from 22 per cent in 2011-12 to 15 per cent in 2012-13. Interest costs as a per cent of sales have gone up to 2.7 per cent in 2012-13 from 2.4 per cent last year. Clearly the decelerating sales and margin pressures have made sure that recent rate cuts haven’t materially eased India Inc’s interest burden.

For equity investors, it seems to be best to avoid high-debt companies and keep with the cash rich ones, until the situation improves.

radhika.merwin@thehindu.co.in

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