Cover yourself against future cuts, lock into current fixed deposit rates

Consider alternatives like SCSS, NSC if you don't have interim liquidity needs

The Reserve Bank of India (RBI) has kept the repo rate constant at two consecutive Monetary Policy Committee (MPC) review meetings. Earlier, bank fixed deposit (FD) rates were rising alongside the increase in policy rates. RBI's pause invites the question whether FD rates have peaked too.

The US Federal Reserve (Fed) also paused this month. “Most global central banks are close to completing their interest rate increases. Commodity prices, such as crude oil, have stayed relatively stable in recent months. This implies that we might be approaching the peak of the interest rate hike cycle,” says Raj Khosla, founder and managing director (MD), MyMoneyMantra.com.

The liquidity factor

Besides RBI rate actions, FD rates are shaped by liquidity within the system. “If liquidity within the banking system remains high, larger banks possessing sufficient deposits to fund their credit growth may halt their FD rate increases,” says Naveen Kukreja, co-founder and chief executive officer (CEO), Paisabazaar.

Khosla cites the example of the State Bank of India’s (SBI) FD rates. Interest rate on two- to three-year FDs rose from 5.10 per cent in January 2022 to 6.75 per cent in December 2022, a jump of 1.65 percentage points. This increase lags behind the 2.5 percentage point hike in the repo rate over the same period. “This indicates banks have sufficient liquidity and are not seeking more funds from customers,” says Khosla.

Kukreja, however, says that banks with smaller deposit bases or aggressive credit growth targets may resort to FD rate hikes.

FDs on a high

FD rates have climbed steadily for several quarters and are at attractive levels. “This is a good time to lock into FDs. Even if we are not at the peak, we are nearing it in the current rate hike cycle,” says Santosh Joseph, CEO and founder, Germinate Investor Solutions and Refolio.

Khosla says one could book an FD at current rates to guard against a downward revision in the future. “In the event of an upward revision, you can always break the FD and reinvest at a higher interest rate,” he says.

Combine with fixed-income options

Alternatives such as small savings schemes are also offering attractive returns. “Among small savings schemes, the Senior Citizens Savings Scheme (SCSS) provides the highest interest rates of 8.2 per cent per annum for a five-year tenure. This surpasses the five-year senior citizen FD and tax-saving FD rates of public-sector banks and large private-sector banks by over 100 basis points. Senior citizens seeking regular income at quarterly intervals with an investment horizon of five years, or those wishing to claim tax deductions under Section 80C, would find the SCSS more beneficial than bank FDs,” says Kukreja.

The National Savings Certificate (NSC) also offers an attractive rate of 7.7 per cent.

Depositors who are not senior citizens should compare rates before investing. “They should compare the interest rates of small savings schemes with FD interest rates, both tax-saving and non-tax saving, offered by private-sector banks and small finance banks. At present, the highest FD slab rates offered by many of these banks like Bandhan, DCB, IDFC First and RBL exceed 7.5 per cent per annum,” says Kukreja.

Corporate FDs offered by AAA and AA-rated entities also offer attractive returns, with yields touching 8 to 8.25 per cent. However, investors should factor in their credit ratings to minimise risks.

What should you do

Consider spreading your investments across tenures with a mix of one, three, five, and seven-year fixed-income instruments such as FDs, NSC, and bonds. This strategy will enable you to reduce reinvestment risk and ensure regular cash inflows.

Remember to factor in your interim liquidity needs when investing in small savings schemes and FDs. Small savings schemes in particular score low on interim liquidity, so invest in them only if you can hold until maturity. In the case of FDs, be sure to check the premature withdrawal penalties.

Finally, align your fixed-income investments with your financial goals by choosing the appropriate tenure.