Are you prepared for the turn?

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: It appears that the interest-rate cycle is about to turn. Fine-tune your financial strategy to profit from the likely decline in interest rates in the first quarter next year

What spurred the Reserve Bank of India (RBI) to announce a cut in the cash reserve ratio (CRR) on October 6 was the flaring up of rates in the overnight call money market. Subsequently, the RBI revised the CRR rate cut by a further 100 basis points (1 percentage point) on October 10. With inflation at 11.80 per cent, the central bank can’t possibly cut the repo rate. So it has chosen to infuse liquidity through a CRR cut. Some time ago, it had taken another measure designed to infuse liquidity: it had reduced the SLR (statutory liquidity ratio) requirement of banks by one percentage point from 25 per cent to 24 per cent. More such cuts (of CRR and SLR rate) could come on October 24, when the central bank reviews its credit policy.

While central banks all over the world are cutting interest rates, the RBI cannot afford to cut the repo rate at present for several reasons. One, inflation remains high at around 12 per cent. Cutting interest rates now could once again stoke inflationary pressures. Two, the rupee is depreciating sharply: it is down 21.8 per cent against the dollar since the beginning of the year. Reduction in interest rates could cause further outflow of capital, thereby causing the rupee to depreciate more. That is not what the RBI would want, given our massive oil import liabilities.

According to economists, in March 2009, when the base effect turns favourable, inflation is expected to drop off sharply. So the central bank is expected to cut rates between January and April. According to Tushar Poddar, vice president, Asia Economic Research, Goldman Sachs, “We think that interest rates have peaked and the central bank will start cutting rates in the first quarter of 2009.”

Veer Sardesai, a Pune-based financial planner, however, points out, “If globally interest-rate cuts are deep, and the differential between global interest rates and India’s becomes substantial, that would give the RBI leeway to cut rates deeper. Otherwise interest-rate cuts in India are likely to be smaller than in the West.”

What is clear is that the interest-rate cycle is about to turn, and that calls for a few adjustments to your financial strategy.

Move to longer-term debt...