Why FD rates are likely to go up?   May 05, 2014



Impact

Rise in the cost of living and increasing demands of our family members make investing your hard earned money extremely imperative. Most people have started realising this and have become avid investors. Many investors prefer investing their savings in safer investment avenues such as bank fixed deposits (FDs), especially in uncertain times such as the present. Surely you must have heard a lot about this fixed income instrument from your family, friends, neighbours etc. To make it easy for depositors to invest in a bank FD, banks also provide the facility of directly debiting your savings account for a pre-determined amount and transferring it to a FD linked with that account. The rate of return on FDs is ranging from 8.0% - 9.0% for 1 year deposits at present, but now it appears that the rate of return on such FDs may go up further, thereby yielding investors with better returns. Dena bank is the first to make such a move by offering a higher rate of 9.15% for 444 day deposits through a 2-month window, and other banks may also follow suit.

So what might prompt banks to increase deposit rates?
The lack of liquidity in the system and tighter market conditions could be factors which may force banks to raise the rate of return being offered to fixed deposit investors. Moreover the rise in inflation can increase the banks’ asset-liability mismatches as investors may be forced to park lower amount of money in fixed deposits and look for other avenues which can counter inflation better (by earning a higher real rate of return). You see, investment avenues such as corporate deposits, tax-free bonds, dynamic bond funds etc., have caught investor attention due to their ability to clock a decent rate of return. Hence in such a scenario to increase their deposits, banks may be forced to hike rates to attract depositors and avoid facing a probable liquidity crunch.

Does the economic scenario and monetary policy action warrant such a move?
Looking at the risk emanating from food inflation, given the official forecast of a below-normal monsoon (on account of 60-65% chances of an El-Nino phenomenon), along with contraction in liquidity, the hike in interest rates by banks’ seems warranted. Banks are aware that the RBI may refrain from reducing policy rates any time soon, at least until inflationary pressures are evident. The Wholesale Price Index (WPI) inflation inched up yet again in March 2014 to 5.70% after depicting a descending trend for the previous 3 months. Moreover, the unseasonal winter rainfall and hailstorm witnessed by some parts of the country, has done probable damage to the Rabi crop produce. Amid such times, if we indeed have below-normal monsoons (due to an El-Nino phenomenon), it could stoke up vegetable prices and hit the common man.

What strategy should investors adopt?
Under the present circumstances, those who wish to invest in bank FDs would benefit if interest rates are hiked. However, a high inflationary scenario could be a disappointment for the equity markets. Going forward, the Indian equity market is likely to keep watch on how the political landscape pans out ahead of the 2014 general elections and would also take cognisance of other macroeconomic indicators both from the domestic as well as the global economy.

PersonalFN is of the view that while you may include suitable fixed deposits in your portfolio, it must be borne in mind that one should never expose his / her entire portfolio to a particular investment avenue. Moreover before putting your hard earned money into any fixed deposit it is imperative that you look into and compare the following features:

  • Credit profile
  • Post tax rate of return
  • Interest pay-out options
  • Tenure of the FD
  • Premature withdrawal clause

PersonalFN believes that you should invest systematically without speculating or guessing the market movements. If you stick to your broader investment plan and asset allocation while investing it will become simpler to make your investments grow even during uncertain times.



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