With further rate cuts, gilt funds are likely to outperform others
If the central bank cuts interest rates in the coming years, gilt and
income funds are likely to outperform other debt funds instruments.
Cooling of interest rates should come as no surprise with wholesale price inflation easing to a 40-month low of 5.96% in March 2013, giving the Reserve Bank of India (RBI) leeway to reduce the repo rate by 25 basis points (bps) to 7.25% at the beginning of May 2013.
This is close to the central bank's comfort level of 5%. The RBI had been raising the repo rate consistently between February 2010 and March 2012, taking the key policy rate to 8.5%. The repo rate is the rate at which banks borrow from the RBI. One basis point is one-hundredth of a percentage point.
"Any material impact on the monetary rate transmission on account of the repo rate cut is unlikely. In spite of a cumulative 50 basis points rate cut along with reduction in cash reserve ratio in the previous two revisions, banks reduced their base rates by a small magnitude of 10-25 basis points only," says Amar Ambani, head (research), IIFL, a brokerage firm. "Having said that, it is a matter of time until this starts translating into lower rates," Ambani adds.
Analysts say interest rates may continue to fall for the next three-five years.
"Over this period, interest rates have to go down significantly. In the next 12-15 months, we may see interest rates coming down by 100 to 125 bps," says Rahul Goswami, chief investment officer (fixed income), ICICI Prudential AMC.
Factors that will influence interest rates include inflation, current account deficit, trade deficit and economic growth.
"We believe that there is tremendous potential for generating returns during the period. There exists plenty of scope for investing in income and gilt funds with a 12-18-month horizon even now," says Goswami.
According to a study by CRISIL Research, gilt funds have given the highest returns in the debt fund category, followed by income funds, in the past falling interest rate cycles.
If the central bank cuts interest rates in the coming years, gilt and income funds are likely to outperform other debt funds instruments.
This is close to the central bank's comfort level of 5%. The RBI had been raising the repo rate consistently between February 2010 and March 2012, taking the key policy rate to 8.5%. The repo rate is the rate at which banks borrow from the RBI. One basis point is one-hundredth of a percentage point.
"Any material impact on the monetary rate transmission on account of the repo rate cut is unlikely. In spite of a cumulative 50 basis points rate cut along with reduction in cash reserve ratio in the previous two revisions, banks reduced their base rates by a small magnitude of 10-25 basis points only," says Amar Ambani, head (research), IIFL, a brokerage firm. "Having said that, it is a matter of time until this starts translating into lower rates," Ambani adds.
Analysts say interest rates may continue to fall for the next three-five years.
"Over this period, interest rates have to go down significantly. In the next 12-15 months, we may see interest rates coming down by 100 to 125 bps," says Rahul Goswami, chief investment officer (fixed income), ICICI Prudential AMC.
Factors that will influence interest rates include inflation, current account deficit, trade deficit and economic growth.
"We believe that there is tremendous potential for generating returns during the period. There exists plenty of scope for investing in income and gilt funds with a 12-18-month horizon even now," says Goswami.
According to a study by CRISIL Research, gilt funds have given the highest returns in the debt fund category, followed by income funds, in the past falling interest rate cycles.
If the central bank cuts interest rates in the coming years, gilt and income funds are likely to outperform other debt funds instruments.
