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The Reserve Bank of India (RBI) has spoken. It
wishes to grant Indian investors increased access/flexibility to
international markets. To that end, a lot of its measures are
explicitly aimed in that direction.
From the retail investor’s perspective, there are
at least 3 points in the Monetary Policy that we have marked for
special mention. In a policy statement that otherwise deals mainly with
macro issues, these are the measures that can impact your finances
significantly. We have given our view on the points with a clear-cut
action plan for the investor.
1. Rates on NRI deposits reduced
In a bid to curtail dollar supply (and thereby tilt the appreciating
rupee-dollar equation), the RBI has reduced the peak interest rate
offered on FCNR (B) deposits (Foreign Currency Non-Repatriable) as well
as on the NRE deposits (Non-Resident External) by 50 basis points each.
With this move, bank deposits are no longer as attractive for NRIs.
Given the rising bond yields in the Indian debt market, debt funds and
fixed maturity plans (FMPs) assume a more important role for the NRI
investor.
NRI
deposits get the thumbs down
| |
FCNR Deposit |
NRE Deposit |
| HDFC Bank |
4.47% |
5.22% |
| (All
data sourced from HDFC Bank’s website. The FCNR deposit rates are
for investments upto Rs 5,000. The effective rate on NRE deposit is
5.32%. The investment tenure for both deposit categories is more
than 1-Yr and less than 2-Yr.) |
In our view, as bank deposits turn unattractive for
them, it is time for NRIs to explore the mutual fund route. Long-term
debt funds (especially of the floating rate category) are candidates
for investment. These funds are well-placed to counter an uncertain
interest rate scenario and if interest rates rise (which is possible,
in our view), then floating rate funds are your best bet.
Floating rate funds are an option
| |
Pre-Tax Return |
Tax Rate |
Effective Return |
| NRE Deposit |
5.22% |
Nil |
5.22% |
| Floating Rate
Funds |
7.00% |
10% |
6.30% |
| (NRE
deposits are tax-free. The investment tenure for both investments
is more than 1-Yr. For simplicity, tax rate on capital gains on
floating rate funds is taken at 10% rather than 20%
post-indexation; the dividend distribution tax is 14.2%. Pre-tax
return over 1-Yr on floating rate funds is assumed at a
conservative 7%, the yield on the 1-Yr Gsec is considerably
higher.) |
Many floating rate funds have given a return in
excess of 7% over the last 12 months, which admittedly is a
backward-looking metric, but tells the investor how much he would have
gained by investing in them (i.e. post-tax return of 6.30% over a year)
vis-à-vis NRI deposits.
Another mutual fund investment that merits mention
is the fixed maturity plan (FMP). In an FMP, the fund manager locks the
yield by investing in a bond with a definite investment tenure (i.e.
the maturity is fixed). In times of rising bond yields (like now, for
instance), the fund manager can lock-in bond yields at attractive
levels.
FMPs
are even more attractive
| |
Pre-Tax Return |
Tax Rate |
Effective Return |
| NRE Deposit |
5.22% |
Nil |
5.22% |
| FMPs |
9.50% |
10% |
8.55% |
| (NRE
deposits are tax-free. The investment tenure for both investments
is more than 1 year. For simplicity, the tax rate on capital gains
on FMP is taken at 10%, rather than 20% post-indexation; the
dividend distribution tax is 14.2%.) |
At present, FMPs with a 1-Yr tenure are offering
yields hovering around 10% (pre-tax), although in our illustration we
have assumed a conservative rate of 9.50%. Compare this to the rates on
NRI deposits and you will realise that even after accounting for the
exchange rate differential, there is a strong investment case for FMPs.
2. AMCs can invest in overseas markets upto US$ 4
bn
The RBI has hiked the investment ceiling for AMCs (asset management
companies) in overseas stock markets from US$ 3 bn to US$ 4 bn. There
is considerable interest in the media whenever this investment ceiling
is raised. To be sure, it has been raised several times, but most AMCs
aren’t excited enough to start investing abroad as yet.
There are two reasons for that. One reason is
because AMCs point out that Indian stock markets have grown (and will
likely grow) a lot more than most other stock markets. So why invest
abroad and lose out on the great Indian opportunity. This argument is
only partly rational; investments aren’t just made for growth
opportunities, there is a diversification angle to it. By investing in
the global stock markets, AMCs, for their investors, can diversify
their risks across other currencies/economies so that a downturn in any
one of them will not prove detrimental to the entire portfolio.
Another reason why AMCs are not enthused with the
idea of investing in global stock markets is because of the taxation
angle. A fund must invest in Indian equities (upto a minimum of 65% of
net assets) to qualify as an equity fund from a taxation perspective.
So taxation-wise, a global equity fund like the Principal Global
Opportunities, which invests 100% in global equities, qualifies as a
debt fund (and therefore does not benefit from zero capital gains tax
on long-term gains)! In our view, unless this anomaly is addressed,
both AMCs and investors are unlikely to view this opportunity with the
interest it deserves.
3. Risk weightage on home loans is reduced
Put simply, the RBI, by reducing risk weightage on home loans, has
paved the way for banks to lower provisioning for home loans. This
implies that effectively banks can reduce rates on home loans, but we
believe that it is unlikely to happen at this stage. Most likely, banks
will continue to offer home loans at existing rates, unless RBI reduces
interest rates in the next Monetary Policy review.
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