PPF rates cut- Is there more to go in terms of reduced interest rates on FDs and EPF/PPF?

Recently there was a lot of hue and cry when Govt cut the PPF rates to 8.1%. Also long term FD rates are coming down drastically in the system. Currently 5 years FDs are fetching about 7.5%( might go even lower after RBI rate cuts in April). Now this is bad news for the savers and those who take unrealistic assumptions for PPF/EPF returns in their retirement planning.

So what is the way forward for interest rates?

If we look at the global interest rates, India still has one of the highest interest rates in the world. See this table and you will realize that Indian interest rates are bound to come down as 70-80% of world economies are having interest rates  less than 3-4%. US is at 0.5% and while Japan and EURO area are having negative interest rates ! Indian interest rates as set by RBI is currently 6.75%. This is with inflation currently around 5.1%. With the formation of new MPC, RBI Gov. Rajan has been given the mandate to keep the inflation between a band of 2-6%. Considering that, 7-8% should be peak for interest rates in the economic. And if Global deflation continues, we might see even lower rates(as low as as 3-4%) in the economy.

While lower interest rates are good for the industry and the economy, for savers and retirees it is bad news. Imagine how savers are managing in developed economies where interest rates are zero or below zero!

This also implies that you can’t afford to be all 100% in debt, you will have to assume some risk and get into equities. Although it is very difficult to say that you will be adequately compensated for taking that risk in equities. Even equity returns would fall from 15-17% CAGR to about 10-12% CAGR(or even lower) for longer periods of time.

So when you are planning for your retirement 20-30 years down the line, keep in mind such return assumptions. Don’t assume lofty returns of 10-15% on your portfolio!In the short term(say 1-2 years), equities might zoom because of global liquidity so it might make sense to be slightly overweight on this asset class. But if global growth doesn’t pick up in next 1-2 years, it will be very difficult to get returns from any asset class except Gold as people will just turn to Gold  for security. Hence, it is always prudent to keep at least 10% of your portfolio in Gold.

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