 "Reserve Bank rate cut will not hit depositors")
Investors in bank fixed deposits (FDs) and small savings schemes could be worried after the Reserve Bank of India (RBI)'s repo rate cut by 50 basis points (bps). Following its decision, the country's largest bank - State Bank of India (SBI) - has already announced it will cut deposit rates by 25 bps from October 5. This will bring the rate on SBI's one to three-year FDs down to 7.25-7.5 per cent, from the current 7.5-7.75 per cent.
However, they need not worry. Due to the fall in the consumer price inflation index, the real interest rates are positive. According to data compiled by BS Research Bureau, three years ago, despite higher fixed deposit rate, the real interest rate for investors was negative. In August 2012, the rate on SBI's one-year deposit was nine per cent. But the consumer price index (CPI)-based inflation was at 10 per cent. As a result, the real return was minus one per cent. By August 2015, SBI's one-year FD fell to 7.75 per cent. But with CPI inflation easing to 3.66 per cent, the real return works out to 3.84 per cent. That is why a cut in deposit rates now might not impact depositors as much as it would have, say, three years ago.
"What matters is whether the cost of living is going up and interest rate is going down. If that is the case, a deposit rate cut will definitely hit. But given that headline inflation is under control and certain things like fuel have become cheaper, the rate cut may not have a big impact," says D K Joshi, senior director and chief economist at CRISIL, adding that some categories like senior citizens might be impact because of the rate cut but it was needed.
Similarly, though RBI Governor Raghuram Rajan has asked for a review of small savings rates as well, its impact might be limited unless there is a sharp cut. In his address to the media he said, "While RBI stance will continue to be accommodative, the focus of monetary action for near term will shift to working with the government to ensure that impediments to passing off bulk of 125 bps cut in policy rate are removed. This includes among other things reviewing small savings rate."
Currently, the government's small savings schemes that offer eight to over nine per cent look more attractive as compared to bank FDs. These include Public Provident Fund, Kisan Vikas Patra, post office deposit schemes, National Savings Certificate, etc.
Deepali Sen, founder Surjan Financial Advisors, said even if small savings rates are cut, the impact may not be large enough for depositors to shift out of such products. "These schemes offer guaranteed returns. Even if their rates are cut, rates of other fixed income instruments will also see a natural alignment." As an alternative, Sen suggests short-term or ultra-short bond mutual funds, which give similar returns. "Small savings schemes have very long lock-in periods," she points out.
The strategy for retail depositors should be to lock into the highest possible FD rate right now, says Manikaran Singal, a financial advisor. "Banks usually offer the highest FD rate for the one-three years tenor. The rate for longer term FDs is usually lower. Given that interest rates are headed southwards, you do face the risk of lower interest rates at the time of re-investment. To balance this, invest in a mix of short-term bank FDs and long-term debt funds."
When interest rates go down, debt funds will give capital appreciation. You can also lock in long-term funds into small savings schemes since typically these rates are changed only closer to the end of the financial year.
However, they need not worry. Due to the fall in the consumer price inflation index, the real interest rates are positive. According to data compiled by BS Research Bureau, three years ago, despite higher fixed deposit rate, the real interest rate for investors was negative. In August 2012, the rate on SBI's one-year deposit was nine per cent. But the consumer price index (CPI)-based inflation was at 10 per cent. As a result, the real return was minus one per cent. By August 2015, SBI's one-year FD fell to 7.75 per cent. But with CPI inflation easing to 3.66 per cent, the real return works out to 3.84 per cent. That is why a cut in deposit rates now might not impact depositors as much as it would have, say, three years ago.
"What matters is whether the cost of living is going up and interest rate is going down. If that is the case, a deposit rate cut will definitely hit. But given that headline inflation is under control and certain things like fuel have become cheaper, the rate cut may not have a big impact," says D K Joshi, senior director and chief economist at CRISIL, adding that some categories like senior citizens might be impact because of the rate cut but it was needed.
Similarly, though RBI Governor Raghuram Rajan has asked for a review of small savings rates as well, its impact might be limited unless there is a sharp cut. In his address to the media he said, "While RBI stance will continue to be accommodative, the focus of monetary action for near term will shift to working with the government to ensure that impediments to passing off bulk of 125 bps cut in policy rate are removed. This includes among other things reviewing small savings rate."
Currently, the government's small savings schemes that offer eight to over nine per cent look more attractive as compared to bank FDs. These include Public Provident Fund, Kisan Vikas Patra, post office deposit schemes, National Savings Certificate, etc.
Deepali Sen, founder Surjan Financial Advisors, said even if small savings rates are cut, the impact may not be large enough for depositors to shift out of such products. "These schemes offer guaranteed returns. Even if their rates are cut, rates of other fixed income instruments will also see a natural alignment." As an alternative, Sen suggests short-term or ultra-short bond mutual funds, which give similar returns. "Small savings schemes have very long lock-in periods," she points out.
The strategy for retail depositors should be to lock into the highest possible FD rate right now, says Manikaran Singal, a financial advisor. "Banks usually offer the highest FD rate for the one-three years tenor. The rate for longer term FDs is usually lower. Given that interest rates are headed southwards, you do face the risk of lower interest rates at the time of re-investment. To balance this, invest in a mix of short-term bank FDs and long-term debt funds."
When interest rates go down, debt funds will give capital appreciation. You can also lock in long-term funds into small savings schemes since typically these rates are changed only closer to the end of the financial year.