Amazon deals

Friday, September 16, 2011

Is the interest rate increase by RBI good or bad for investors?

Increasing interest rates are great for older investors and retirees. Their loans have mostly been paid off. They rely more on stable fixed income instruments, and higher interest rates are always welcome even if it isn't enough to cover inflation.
For younger investors, who can afford to take more risk and invest in the stock market or mutual funds, higher interest rate is bad news. Why? Because stock markets and rising interest rates are inversely proportional. Many market players use loans and margin money to invest. Their costs increase and make their leveraged investments unviable. Companies have to pay more interest, which affect their profits. They tend to hold back on capital expenditure, which affects growth.
As growth starts to slow down, the investment environment changes from bullish to bearish. Investors start to book profits, and move to safer havens like bank fixed deposits and gold.  The Sensex starts sliding which leads to more selling. It has a spiralling effect.
Doesn't the RBI know all this? Why are they increasing the repo and reverse repo rates again and again? Don't they know that growth is getting stifled?  The short answer is: they know what they are doing. But the RBI is caught between the devil and the deep blue sea. With inflation threatening to go out of control, increasing interest rates is the only tool they have - even if it causes a short-term growth slow down.
Unfortunately, the government is not playing its part. Bold policy changes are the need of the hour - FDI in multi-product retail, industry-friendly labour policies, unified tax regime are some of them. But such policies may upset the apple-cart - the nexus between politicians and their crony middlemen. The greater good is being sacrificed so a few people can get incredibly rich. Cutting out the middlemen will immediately put a tight leash on inflation. Interest rates can then be lowered and the economy will get back on the growth path. But that seems like wishful thinking.
What are the likely next steps? For the RBI, probably more rate hikes till the base effect kicks in and the inflation rate starts to moderate. For young investors, the stock market is unlikely to make new highs any time soon; so a good time to read up and, hone stock-picking skills. Lower levels of the Sensex may provide good opportunities to enter. For older investors and retirees, enjoy the high interest regime while it lasts.

No comments: