Following two consecutive repo rate hikes by the Reserve Bank of India (RBI) in May and June, fixed deposits are gaining lustre after a lengthy period of low interest rates.
After its monetary policy meeting on June 8, the RBI raised the repo rate by 0.50%, bringing the total hike to 0.9% in 36 days.
This is good news for fixed deposit (FD) investors, who have seen interest rates drop by 40% in six years, from the highest of 9% offered by the State Bank of India (SBI) in September 2014 to 5.4% in May 2020, according to The Economic Times.
Low fixed deposit interest rates primarily harmed senior citizens who rely on FDs for a steady income.
Banks have begun hiking FD interest rates in response to the RBI raising its policy rate. Fixed deposits have long been a favourite of low-risk investors looking for a guaranteed return.
However, before investing in FDs, investors should be aware of certain realities.
Rates are Gradually Increasing
When the RBI adjusts policy rates, lending rates rise first, followed by FDs. The benefit of the rate hike takes time for banks to pass on to depositors. This is also due to the fact that banks have ample liquidity and are not in a hurry to attract deposits.
Apart from the sluggish transmission, investors should be aware that banks give the biggest interest rate increases on long-term fixed deposits, which are typically three years in duration. In most situations, the rate hike on popular one- or two-year deposits is simply 10-30 basis points.
“Secondary market yields have risen dramatically across tenures as a result of the rising interest rate cycle.” “It would take some time for bank fixed deposit rates to rise,” corporate trainer Joydeep Sen told moneycontrol.
Rates Might Rise To 7%
Following the RBI’s 0.9% interest rate hike in just 36 days, experts anticipate the RBI could raise rates by another 50-75 basis points in the following 2-3 quarters. The 10-year G-sec yield, which is currently over 7%, is another measure of long-term interest rates. As a result, despite the delayed transmission of rate hikes, bank FD rates may exceed the 7% threshold in the next 6-9 months.
As a result, this may not be the best moment to invest in long-term FDs or renew a large FD. During a rising rate scenario, it is preferable to invest in short-term fixed deposits so that the investor can benefit from the rate climb later. The investor can renew the FD for a longer duration at a greater rate once the short-term investment matures.
Laddering for FD
Making an FD ladder, according to some experts, allows an investor to break a large deposit into pieces with varied time maturities and get an average return even when interest rates are volatile.
According to Mumbai-based certified financial adviser Parul Maheshwari, keeping cash while waiting for rate hikes means earning less for the time being.
“Rather, take into account your cash flow demands and invest in a mix of one-, two-, and three-year fixed deposits,” Maheshwari advised. When the deposits mature, the investor has the option to reinvest the funds at current interest rates.
Experts suggest it’s best to ladder or stay in short-term fixed deposits rather than five-year or longer fixed deposits.