Repo Rate Cut

Just imagine, one fine day you are having your morning coffee, checking the news, and suddenly one update grabs all your attention: that is, the RBI has cut the repo rate by 25 basis points. 

If you are someone who prefers investing in debt mutual funds, then the news might be okay for you. But do you know about its function in your investment? Well, that’s a very good question! No matter whether you are a pro-investor or just a beginner, this discussion will resolve all your doubts. So, without any further ado, let’s begin the discussion. 

What Is Repo Rate? 

Before jumping straight to the topic, you must be aware of what a repo rate is. It is nothing but the interest rate lent by the RBI (Reserve Bank of India) to the commercial banks. Let’s make it simpler for you. Imagine a bank needs short-term money; it will directly go to the RBI. Now, the cost of borrowing money is known as the repo rate. 

When the RBI cuts the repo rate, it will sound like the central bank is telling commercial banks that they are making borrowing cheaper for them. And when there is a hike in the rate, that means the RBI is doing the opposite. 

Now another question should come to your mind: why should the RBI cut the rate? In most cases, to stimulate the economy, control inflation, and boost growth, RBI makes such decisions because a lower interest rate will always encourage borrowing, investment, and spending. 

How Do Debt Mutual Funds Get Affected By The Repo Rate Cut? 

We are all a little bit aware of the debt mutual funds. It basically refers to corporate bonds, government bonds, treasury bills, and similar fixed-income securities. As they provide a fixed income, these instruments are extremely sensitive to interest rate changes. Let’s identify them right below. 

1. Yields Get Fall

If you are a long-term investor, you will definitely have noticed that when the bond price rises, the yield (which refers to the return you receive from the bond, depending on the current price) falls. In such a situation, if you are already holding a debt fund, then it will benefit from the rise in bond prices during the rate cut. To the new investors who are investing after the rate cut, you might experience a lower yield in the future, as new bonds will tend to offer low interest rates. 

2. Long-Term Debt Funds Grow

During the repo rate cut, long-term debt funds get significant appreciation because they invest in bonds that are far from maturity in the future and are comparatively sensitive to interest rate movements. Therefore, these funds in the long term give more benefits to the investors. 

3. Bond Price Rises

There is an opposite relationship seen between the interest rate and bond prices. When the interest rate falls, the existing bond becomes more attractive with the higher interest rates. During the rate cut period, the net asset value of the fund rises, which gives investors positive returns. 

What Investors Can Do During the Repo Rate Cut?

Once you have an overall knowledge of the mechanism of repo rate cuts, now is the time to understand what you can do as an investor during that period. Identify them below. 

1. Diversification is a good idea. When you mix and match long-term and short-term funds, it can help you to balance your portfolio. 
2. Constantly try to stick to your goal. No temporary interest rate movement should affect your financial goals and time horizon when you invest in a debt fund. 
3. When the rate is falling, debt funds with long duration are always better, but they are also more volatile as well. In the same way, credit risk funds can offer higher returns, but it also comes with risk. Know this clearly before you invest. 
4. During the rate cut, people often get excited for debt funds, but we suggest you avoid rushing and evaluate your personal risk tolerance level, liquidity need, and tax implications before investing. 

Which Debt Funds Grow Well After A Rate Cut? 

After the repo rate cut, if you want to start investing, then go for these debt mutual funds. 

1. Long Duration Mutual Funds are always best, as they benefit the most when the interest rate falls. 
2. Dynamic Bond Funds are actively managed funds that allow fund managers to shift the duration depending on interest rate expectations. When you want a balanced approach, this one works well. 
3. Gilt Funds generally invest in government securities; therefore, they are highly sensitive to interest rate changes.

Also, Check – Interest Rates and Mutual Funds

Closing Thoughts 

We hope now the term repo rate cut isn’t that complicated for you. So if you see any news regarding these rate cuts, you would be able to consider it as an opportunity. If you want stability with capital appreciation, then repo rate cuts are a solid option, especially when the rate is falling. Just keep one thing in mind: when the repo rate cuts boost returns in the short term, it is your long-term strategy that will matter. So, go accordingly. 

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Disclaimer – This article is for educational purposes only and does not intend to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before investing.