Real returns get better for retail investors

RBI's focus on controlling consumer inflation and raising of rates should see elevated levels of real returns

With long-term interest rates inching higher and inflation trending lower, retail investors have finally begun to see an improvement in their real rates of return (the interest rate after adjustment for inflation).

Consumer price inflation was at 9.52 per cent in August, whereas returns from corporate bonds, fixed maturity plans and debentures have been at 10.5-12.5 per cent in recent times. Real rates of returns have improved by 100-300 basis points (bps), depending on where one invests. A few months earlier, the interest rate on fixed income products was 8.5-9 per cent, while retail inflation was higher than 9.5 per cent.

Says Dwijendra Srivastava, head, fixed income, Sundaram Mutual: “Given that retail inflation is expected to come down and corporate returns are higher, a better real return is possible for the investor. Having said that, it depends on how inflation actually turns out for investors.”

The real rate of return is now 250 bps-positive; in January, real rates were a negative 50-150 bps for retail investors.

Says Ajay Bagga, head, private wealth management, Deutsche Bank: “Investors are getting a positive real rate of return from fixed income investments in the past few months, as against negative returns last year, and that's a very good sign from the retail investors’ perspective."

As the Reserve Bank is expected to increase its focus on consumer price inflation, real interest rates could remain elevated in the coming months or, at least, positive for investors. In its new policy framework, RBI has clearly targeted inflation as the priority. It is likely to assign a higher weight to consumer price inflation (CPI) as against only targeting the wholesale price index (WPI), say economists.

In a note, economist Sonal Verma of Nomura said the policy marked a regime shift in RBI’s operating framework. “It is clear that WPI inflation measures are becoming secondary, while RBI is assigning a greater relative weight to CPI and core CPI inflation, as it believes that inflation expectations are shaped by the latter. In particular, we believe that core CPI inflation has a greater probability of becoming the new medium-term nominal anchor,” she said.

Unlike most central banks, RBI has been largely deciding its monetary policy based on the WPI. CPI inflation was 9.52 per cent in August as compared to 9.64 per cent in July, while WPI inflation was 6.1 per cent in August against 5.79 per cent in July. CPI measures inflation for the retail consumer, while WPI measures wholesale prices.

Experts say targeting the CPI is the only way to attract more savers into the economy. There was a decline in the net financial savings of households to eight per cent of gross domestic product in 2011-12 from 11-12 per cent the previous year, estimates the Prime Minister's Economic Advisory Council.

Says Srivastava: “The new (RBI) governor is looking at improving the savings rate in the country and that to me is a positive sign.”

The governor had earlier said RBI would issue new inflation-indexed bonds based on the CPI; this might happen as early as November. The previous issue of inflation-indexed bonds was based on the WPI.