Some recent debt issues (like IDBI Flexibonds 3) have shown hardening of interest rates of late. But, on an overall basis, interest rates on debt instruments have reduced in the recent past and they may reduce further in future.Even if these rates remain at current levels for some time, they have significant implications for individual investors. Investors would do well to understand these implications in order to enable them to suitably modify their investment strategies, where required: Lowering of rate of inflation. Reduction in interest rates has been accompanied by a lowering of the annual rate of inflation in the last two years or so. This has meant that the real rates of returns to investors have not declined as much as the declining rates of interests seem to suggest. In fact, the real rates of return might have gone up. In such a situation, it makes sense to increase investment in safe debt instruments as the situation may not last for long.
But, before investing in such schemes, it isimportant to calculate the ``real rate of return''. This can be done by subtracting the annual rate of inflation from the annualised return indicated by the debt scheme or instrument which is under consideration. What is important here is that while considering the rate of inflation, increase in the ``consumer price index'' should be taken into account and not the increase in the ``wholesale price index''.
It may be pertinent to note here that the rate of inflation highlighted in media is, more often than not, the one which is calculated on the basis of increase in the wholesale price index. And consumer prices often rise faster than the wholesale prices. Nevertheless, even after taking into account the inflation rate worked out on the basis of consumer prices at present, we have a situation where real rates of returns have gone up in many schemes or instruments such as NSC, PPF, UTI's Monthly Income Plans (with assured annualised returns for the entire tenure of the scheme) and IDBI Flexibonds etc.Therefore, investing in such schemes at present may be profitable for investors.
In case of provident funds, however, the rate of interest is declared yearly. So, there is a likelihood of change in the rate of interest and consequently in the real rate of return from one year to the next. In schemes like NSCs or IDBI Flexibonds, such a risk may not be there. But provisions for put and call options must not be lost sight of while investing in long-term schemes. In brief, it is of paramount importance that we always take a look at real rates of returns and not merely look at the softening of interest rates and get disappointed by it. Last but not the least, opportunities for earning a higher and safe real rate of return should not be missed.
Problems of senior citizens
Individual investors can take advantage of higher real rates of returns as explained above. But, for those senior citizens who depend solely or mainly upon fixed monthly interest for leading post retirement life, falling interestrates pose serious threat. This is because reduced inflation rates mean that the rate of increase in prices has reduced and it does not mean that prices themselves have reduced. On the other hand, reduced interest rates may mean that interest income has actually reduced in real terms.
Thus, falling interest rates for such persons mean a situation where reduced income is accompanied by increasing prices even though rate of rise in prices may reduce in an era of lower inflation rate. And this highlights the need for including annuities too in one's investment portfolio even though the annualised return on investment in such annuities may appear to be rather low.
Investors, whether they are young or senior citizens, can't ignore to take a close look at the implications of falling interest rates. Therefore, increase your interest in lowering of interest rates and take the requisite action, well in time.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
