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Why lower interest rates can mean good news for equity

For you and me, as well as companies we invest in, this can potentially mean lower interest rates on the loans we seek from banks and such institutions.

As the economic damage of managing a pandemic became clearer, the Reserve Bank of India responded with sharp 75 basis points cut in the benchmark Repo rate. The repo rate in the Indian economy is the interest rate at which the Reserve Bank buys bonds from commercials banks in a bid to increase liquidity in the system. 

Ideally, this fall then translates to lower lending rates offered by commercial banks to their customers – both individual and corporate borrowers. For you and me this can potentially mean lower interest rates on the loans we seek from banks and such institutions. However, it also means lower earnings on deposits kept with banks be it savings or fixed deposits. 

Lower return on your deposits

If you consider State Bank of India as the benchmark deposit holder for the country, its savings bank account rate is down to 2.75% per annum and a 1-10-year fixed deposit will earn you 5.7% per annum. HDFC Bank’s rates are at 3.5% and 6.15% per annum respectively; only slightly better than SBI. 

This return from money lying in your savings bank account will not cover annual inflation. Post-tax the fixed deposit return too is paltry. Deposits are stable return products, but your earnings don’t cover inflation. This means at the end of a year, your money would have de-grown in value. 

This benefit also transfers to corporate borrowers. These are companies, manufacturing or services, which borrow from banks. With lower interest rates, it means their interest expense will be lower on incremental borrowings and some may be able to renegotiate existing loans too. This then translates to lower cost or expenses in the financial statements. 

The positive

On the flip side, hopefully, lending rates fall too and that will lead to some reprieve on your interest due for long term loans. You can renegotiate your monthly repayments as per the new lower interest rates if you are permitted by the terms of your loan. 

This benefit also transfers to corporate borrowers. These are companies, manufacturing or services, which borrow from banks. With lower interest rates, it means their interest expense will be lower on incremental borrowings and some may be able to renegotiate existing loans too. This then translates to lower cost or expenses in the financial statements. 

While this impact may take a while to show up, eventually lower rates help industries to increase their borrowings and grow capacity. This is a positive point for equity shareholders. In general, low-interest rates are positive for equity shares. While in today’s environment one has to look at many other variables, given the pause in industrial activity, nevertheless, lower rates are welcome if you are a shareholder. 

What you need to consider

If low rates are going to impact your ability to earn returns, you have to consider balancing this with the long-term positive impact on equity holdings. Lower the rates on your deposits, the more you need to consider for taking calculated and adequate equity risk to compensate and grow your wealth in the long term. 

Moreover, as mentioned above, lower rates benefit corporates and that in return benefits equity holders. The current market environment is high on risk and its unadvisable to switch or shift completely, but regular investing in equity should continue for long term wealth creation, especially now that fixed return options are not going to earn much at all. 


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