Fixed deposits are among the safest investment instruments offered by banks in India. Read this article to find out whether the interest rates on such deposits are expected to rise shortly.
Fixed deposit is a traditional investment tool offered by all banks and most of the financial institutions in India. Investment in fixed deposit is usually done keeping in mind factors like tenure, interest rate, loan facility, overdraft facility, pre-withdrawal charges etc. Interest rate is one of the most important factors that attract the attention of investors in India.
They are always on the lookout for banks and financial institutions that offer a higher rate of interest because the interest rate determines the returns that an investment will earn. The interest rates are determined by the bank, and are uniform throughout the tenure of the fixed deposit scheme. So, who determines the interest rates? This article will guide you in understanding the mechanism of interest rates and investments in India.
Banks and financial institutions are the providers of fixed interest instruments in India. Similarly, these institutions play a role in deciding interest rates that are to be offered to their investors. The banks determine the interest rates to be offered across the financial spectrum by keeping in mind the economic conditions prevailing in India. There are various factors that affect the rise or fall of fixed deposit interest rates but one of the key factors is the repo rate.
Fixed deposit interest rates and repo rate have a close correlation between them. These factors closely work in the Indian economy and determine various interest rates. Fixed deposit rates that are to be offered by banks are also determined by considering the repo rates. Repo rate is one of the most powerful factors that regulate the money supply, and interest rates in India.
What is Repo Rate?
Repo rate is the rate at which commercial banks borrow funds from the Reserve Bank of India in times of financial shortage. Repo rate is one of the most powerful tools used by the Reserve Bank of India to keep inflation and money supply in the economy under control.
How does Repo Rate Impact the Economy?
Reserve Bank of India determines the repo rate and keeps on changing it as per the macro-economic parameters prevalent in India. The change in repo rate impacts every sector of the Indian economy. One of the most impacted sectors is the banking sector, where the slightest change in the repo rate affects the lending and borrowings of the banks and financial institutions.
How are Repo Rate and Bank Deposit Interest Rates Correlated?
When the repo rate is increased by the Reserve Bank of India, it directly affects the cost of borrowings for the banks. Banks therefore have to work towards attracting fixed deposit investors so that they are able to create a corpus for lending. With the reduction in repo rate, banks are usually expected to reduce their FD rates as borrowings directly from the Reserve Bank of India become cheaper. Kindly note, the reduction in repo rate might not proportionately affect the interest rates offered by banks.
What Happens when Bank Deposit Rates are Likely to Increase?
When the banking sector is expecting a rise in FD rates, it would imply that the banks are seeing a growth in credit disbursement i.e. a lot of people are opting for the loan facility. So, in order to satisfy the need of credit, banks usually shift their reliance on fixed deposits. For attracting the depositors, banks and financial institutions offer higher interest rates on fixed deposits. Thus, many leading credit agencies believe that when there is more demand for credit from the banks, then banks tend to provide higher interest rates to depositors. In this manner, banks can facilitate the credit needs of their customers by borrowing either from the Reserve Bank of India or from their depositors.
On considering the current performance of the credit growth in the Indian economy, it is observed that it is currently pacing up for achieving newer heights, but at the same time, the deposit growth seems to have slowed down. The loan-to-deposit ratio has gone up in recent times due to cash crunch caused by defaults by ‘Infrastructure Leasing and Financial Services Ltd.’ and demonetization. As per the JM Financials’ Bank report dated 7th January, the credit-to-deposit ratio saw the all-time high since March 1971, the current ratio is 78.6% as of December 2018. Seeing the given statistics, if the credit growth continues its march ahead it can be said that banks might make the big announcement of offering higher and attractive FD rates. If you see your bank offering a higher FD interest rate here is what you should do.
Evaluate your fixed deposit investments
The first step after the increase in fixed deposit interest rate is to evaluate all your fixed deposit investments. If the expected rise in interest is much more than the previous interest rate at which you have invested in fixed deposit then evaluate whether pre-withdrawal and re-investing makes sense or not. While evaluating investments based on premature withdrawal, do keep in mind about the penalties and low returns due to the liquidation of fixed deposit prematurely.
Do not rush
One of the most important factors that determine good investment strategy is not to rush. Even if you believe that the FD rates are expected to be on the rise in the near future, do not rush into locking your investments for longer tenure as the FD rates might increase. In such cases, lock-in your investments for 6 to 18 months tenure and as they mature, you can again invest them with higher fixed deposit interest rates
When the fixed deposit interest rates increase in India then apart from investing in fixed deposits you can do the next best thing i.e. diversify your investment portfolio and start investing in other investment tools, like recurring deposits, NSC, SCSS or Kisan Vikas Patra. It is usually observed that when the FD interest rates increase in India these investment tools also offer higher interest rates. Choose for shorter tenure instruments as said above.
Say NO to long term debt funds
If most of the market researchers are to be believed then it is usually seen that when the fixed deposit interest rates increase in India, the prices of the long-term debt funds fall. So, investing in long-term debt funds will fetch lower returns in the long run and may even witness a negative fall if interest rates spike.
Thus, we can summarise that the FD interest rates are expected to increase in India as the banking sector is witnessing a historic rise in credit growth. So, the banks will open doors for their depositors and offer attractive FD rates. Investment tip: it is a good time to invest for shorter tenures and exit long tenure investment tools.
Recommended Read: Are Fixed Deposits a Good Investment?