Interest rates, particularly the RBI’s repo rate, remain a pivotal influence on the investment landscape, shaping liquidity conditions, borrowing costs, and the strategic decisions of investors navigating a complex macroeconomic environment
But how exactly do repo rate movements connect with floating rate funds? What should investors watch out for? And why are these funds often discussed during times of economic change? Let’s unpack all of this in a way that’s practical, easy to understand, and relevant to everyday investors like you.
What Are Floating Rate Funds?
Floating-rate funds are a type of debt mutual fund. They invest primarily in bonds or debt instruments where the interest rate isn’t fixed. Instead, the rate resets periodically, based on a benchmark, such as the repo rate or other short-term rates like the MCLR.
Here's how they generally work:
- The fund holds instruments that reset their interest rate regularly.
- These resets happen every few months, depending on the terms.
- So, when the repo rate rises, the returns on these instruments go up too.
Understanding the Repo Rate in Simple Terms
The repo rate is the rate at which the RBI lends money to financial institutions for short durations. It's a powerful tool used to manage inflation, control the money supply, and support economic growth.
When the repo rate changes, it has a domino effect:
- Loan rates go up or down.
- Deposit rates adjust accordingly.
- Debt mutual funds including floating rate funds react too.
This is why tracking repo rate announcements matters even if you’re not borrowing or depositing money directly. These rate changes influence the entire financial system.
How Repo Rate Affects Floating Rate Funds
What do repo rate hikes or cuts mean for these investments?
When the Repo Rate Goes Up:
- The interest earned by the instruments in the floating rate fund usually rises.
- Since the rate resets periodically, returns improve over the next cycle.
- There’s less price drop compared to long-term fixed-rate bond funds.
In simple words, rising repo rates often work in favour of floating rate funds. They don’t lose value the way long-duration bond funds might.
When the Repo Rate Goes Down:
- The interest on floating rate bonds adjusts lower at the next reset point.
- So, over time the yield reduces, although not drastically overnight.
- Returns may drop, but these funds still tend to perform more steadily than some other debt instruments during rate cuts.
A Quick Comparison: Floating Rate vs Fixed Rate Funds
Here’s a table to show how floating rate funds stack up against fixed rate funds:
| Feature | Floating Rate Funds | Fixed Rate Funds |
| Interest Structure | Variable, resets with rate changes | Fixed throughout the term |
| Performance in Rate Hikes | Improves as coupons reset higher | May fall due to a drop in bond prices |
| Sensitivity to Duration | Generally lower | Higher, especially for long-term |
| Best in | Rising interest rate periods | Falling interest rate periods |
Why Investors Turn to Floating Rate Funds in Rate Hike Cycles
- They offer better yields in rising rate environments.
- Their shorter duration makes them less volatile.
- Investors don’t suffer as much from falling bond prices.
In short, they provide a buffer against interest rate risk. For many Indian investors, especially those looking for stable income with lower risk, this is an appealing proposition during uncertain times.
How Financial Institutions Adjust to Repo Rate Shifts
When there are repo rate hikes:
- They may have to pay more to borrow funds.
- So, they pass on this cost via higher interest coupons on new bond issuances.
This is what benefits floating rate funds—they pick up these instruments with increased yields and transfer the benefit to you, the investor.
Who Should Consider Floating Rate Funds?
These funds aren’t just for seasoned investors. Even conservative or first-time investors can look at them under the right conditions.
Ideal for:
- Investors wanting to protect their capital during rate hikes.
- Those looking for a debt alternative with more flexibility than FDs.
- People aiming to balance their fixed income portfolio.
Floating Rate Funds vs Other Debt Options
| Investment Type | Interest Structure | Liquidity | Best For |
| Floating Rate Funds | Variable | High | Rising repo rate environment |
| Fixed Deposits | Fixed | Low | Capital preservation |
| Liquid Funds | Market-Linked | Very High | Short-term parking of funds |
| Long-Term Bond Funds | Fixed | Moderate | Falling interest rate cycles |
Tips before Investing
If you’re thinking of investing in floating rate funds, here are a few things to keep in mind:
- Check where the fund is investing - look for high-quality papers.
- Understand the duration and reset frequency of the instruments.
- Compare expense ratios - a high cost can eat into your real returns.
- Don’t expect miracles overnight - returns improve over time as rates reset.
Most importantly, ensure the fund fits your overall portfolio and matches your financial goals.
What’s Happening Right Now?
As of April 9, 2025, the RBI reduced the repo rate to 6.00%, marking the second cut this year. Market expectations point to a further 25 basis points reduction in the upcoming June MPC meeting, reflecting the central bank’s cautious easing stance amid subdued inflation and the need to foster growth against a backdrop of global economic uncertainties.
The reverse repo rate continues to hold steady at 3.35%, while the Bank Rate and Marginal Standing Facility (MSF) Rate are now both at 6.25%. The Standing Deposit Facility (SDF) Rate is at 5.75%.
Conclusion
Understanding the repo rate and keeping an eye on what the RBI is signalling can help you decide when to step into or step away from floating rate funds. For Indian investors looking for a middle ground between safety and performance in their debt portfolios, these funds are worth exploring, especially when rates are moving upwards.
