Yesterday (on August 5, 2014), the Reserve Bank of India (RBI) kept policy rates unchanged in 3rd bi-monthly monetary policy for 2014-15. Such a move was very much on the expected line, especially when stickiness in inflation yet remains.

You see, after an initial slow progress of monsoon and uneven spatial distribution, while the deficiency has narrowed down to 19% (as per the latest report on the Indian Meteorological Department) from 21% earlier, the fears are not entirely dispelled yet. Prices of vegetable, fruits and protein based items are sailing high and therefore the RBI has decided to continue closely vigil on inflation developments. The central bank remains committed on disinflationary path of taking Consumer Price Index (CPI) inflation to 8.0% by January 2015 and 6.0% January 2016. The RBI has said, while inflation at around 8.0% in early 2015 seems likely, it is critical that the disinflationary process is sustained over the medium-term. Thus in this backdrop, it appears unlikely that RBI would reduce policy rates this calendar year.

But banks may start cutting rates on fixed deposits soon…

Bankers are of the view that deposit rates will start coming down before the lending rates do. Recently in the Business Standard, Mr CVR Rajendran, the CMD of Andhra Bank was quoted saying, “While deposit rates will apply immediately to the deposits that come for re-pricing, there has to be a lead time to adjust the lending rates.”

Would reduction in deposit rates be a rational move?
It is noteworthy that the RBI has been actively addressing to liquidity concerns in the banking system through reduction in Statutory Liquidity Ratio (SLR) and special term repos. The SLR reduction of 50 basis points in the 3rd bi-monthly monetary policy has an effect of infusing nearly Rs 40,000 crore into the banking system. Likewise through 9 special term repos during June and July 2014, already Rs 94,000 crore has been infused into the system. So liquidity conditions have remained quite stable.

This unlike the situation in February and May 2014, where lack of liquidity in the system and tighter market conditions, led to some banks increase interest rate on Fixed Deposit (FDs). For instance, Dena Bank made the first move then by offering a higher rate of 9.15% for 444 day deposits through a 2-month window.

At present bank FDs for tenure of 3 years, are offering rate of interest of 9.0-9.5% and those for tenure of 1 year, 8.0-9.0%; depending on the bank you opt for.

What should you as an investor do?
PersonalFN is of the view that, those who are extremely risk averse and do not want to have exposure to market risk can consider investing in bank FDs taking advantage of this elevated interest rate scenario. But while you invest in FDs and make a choice, it is imperative to compare and look into the following features:
 

• Credit profile (i.e. financial robustness)
• Interest pay-out options
• Tenure
• Premature withdrawal clause
• Post-tax returns
   

Likewise, corporate deposits can also be considered if you can take slightly high risk; but again due weightage should be again be given in understanding the nature of the business along with the aforesaid facets.

Notwithstanding the above, it should be noted that the interest earned on FDs (both bank and corporate) is taxable as per your income tax slab. Thus after accounting for tax along with inflation, the post-tax real rate of return you earn on your FDs could be diminutive or even in negative.

Those who can bear a little market related risk, debt mutual funds can be better option; provided one is willing to have an investment time horizon which is tax conducive, especially for those who are in the mid or the highest tax bracket (taking into account tax implication on debt mutual funds introduced in budget 2014-15). For individuals who are placed in the highest tax bracket (of 30%) investing debt mutual funds for long-term (i.e. more than 36 months) is still beneficial because the gains will be taxed at lower rate (of 20%). And it may be negligible with the indexation benefit availed. Moreover, the tax payable would be applicable only at the exit from the scheme at a gain, which is unlike in case of an FD where the earned during a financial year is subject to tax on an accrual basis at the marginal rate of taxation (i.e. as per the income tax slab). For individual in the mid tax bracket (of 20%) however it’s a tough choice if they are investing for a period of more than 36 months. Nevertheless if the indexation benefit is availed of and the indexed cost is high, investing in debt funds can yet be beneficial as against parking money in bank fixed deposit. Having said the above, care should be taken while selecting debt mutual funds and one needs to be very sure about his risk appetite and time horizon to make the right choice from various categories of debt mutual funds.

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