Elevated inflation will determine future interest rates
Interest rates depend upon inflation to a great extent. The RBI has a mandate to keep retail inflation in a range of 2% to 6%. After coming down to the lowest level of 4.31% in May 2023, retail inflation again rose to 4.81% in June 2023. Going by the recent spurt in overall prices, the chances of it going beyond the tolerance range of the RBI cannot be ruled out. So, any significant rise in inflation may compel the central bank to go for a rate hike.However despite a surge if infaltion remains within tolerance range the banking regulator may not go for a rate hike. “FY 24 inflation has been revised upward from 5.10% to 5.4%. Proactive government measures to curb food inflation should assist in keeping inflation lower. RBI likely to stay on hold for rest of CY 2023,” says Deepak Agrawal, CIO- Fixed Income, Kotak Mahindra Asset Management Company.
Another factor that compelled the RBI to raise rates was hikes in rates by other central banks mostly in the US and Europe which were dealing with alarming high inflation. They went overboard in curbing inflation by hiking interest rates in an unprecedented manner.
“The US Federal and Bank of England have already announced hikes making it challenging for RBI to strike a balance to keep inflation under its tolerance levels and factor in rising borrowing costs. While the fight against inflation is not over yet, the RBI has ensured control,” says Adhil Shetty, CEO, Bankbazaar.com.
However, now that the threat of recession in the US and many parts of Europe can do a balancing act as growth concerns may get relatively higher priority and central banks may refrain from hiking rates further. This will have balancing effect in India and reduce the pressure on RBI to hike rates immediately.
Mixed trend in fixed deposit interest rate
After remaining at the lowest level seen in the last two decades, interest rates on fixed deposits started rising significantly after the RBI started hiking repo rates last year in May 2022. Within the next 10 months, the central bank raised the repo rate by 2.5% till February 2023. However, there has been no hike since then, which shows that the cycle of interest rate hikes to curb alarming inflation has ended. The 10-year G-sec yield has largely been range bound between 6.9% and 7.2% since May this year which also shows that interest rates have more or less stablised at this level.
The trend of rising interest rates has reached close to its end as some banks have already gone for a reduction in interest rates. Back when RBI was hiking the repo rate, banks followed suit in raising their FD rates, however, with a lag and it has continued until now. Banks that were slow in raising their interest rate on FDs have been raising rates to catch up. On the other hand, banks, which were quick in raising their rates, have started reducing their interest rate.
As far as transmission of overall 2.5% repo rate hike is concerned it has largely happened in case of FD rates as the increase in the weighted average domestic term deposit rate (WADTDR) on fresh deposits has been 231 basis points in the current tightening phase between May 2022 and June 2023. So unless there is a fresh hike in repo rate chances of any signficant surge in FD interest rate is unlikely.
On July 26, 2023 Axis Bank reduced FD interest rate by 10 bps on its FD with tenure ranging between 16 months to less than 17 months. IndusInd Bank has reduced the interest rate by 25 basis points (bps) on a tenure of 1 Year 7 months up to 2 Years from 7.75 to 7.50 percent for general citizens which is effective on August 5. The mixed example is from Bank of India which reduced the interest rate up to 1 percent across the tenure but introduced a special FD called Monsoon Deposit with the highest interest rate of 7.25% for FD with special tenure of 400 days.
What should FD investors do?
If you have funds that can be invested in FDs, then waiting for interest rates to rise further may not be the best idea. The chances of interest rates rising further cannot be ruled out completely, however, the likelihood of the rise does look low. Currently, the prevailing interest rates may not be the peak interest rates but they are very close to the peak rate seen in the last 3-4 years. Therefore, it may be the best time for FD investors to book their FDs.
“For retail investors, this is a good time to lock in their desired fixed-income allocation in bank FDs. 10 year Gsec yields after having fallen to 7% in June have risen to 7.2% in August. Investing in long duration debt funds can also be a good strategy. As the interest yields start falling, the capital appreciation of long duration bonds can give good returns,” says Anshul Gupta, Co-Founder and Chief Investment Officer, Wint Wealth.
Best rate for medium-term FDs?
Most banks are currently offering their highest interest rates on FDs with tenure typically between 2-3 years. So, if this tenure matches your investment horizon, then you would be better off by booking medium term FDs now.
If your long-term FD is locked at an extremely low rate and has 2-3 years of tenure left, then you may consider the possibility of breaking your FD and reinvesting it at a higher rate in a medium term FD. However, you need to do a proper net benefit analysis as breaking the FD may come with some penalty. After analysis, if there is net benefit, it may be a good time to break your old FD and reinvest it.
Should you book long-term FDs now?
FD investors looking to book their fixed deposits for long tenures face the biggest dilemma about the right time to lock in their deposits. If they book it now and interest rates rise further, they may lose on the additional interest rate. However, if they wait too long and if the interest rates go down, they may end up losing both on account of waiting without earning higher interest and then settling with a much lower interest rate than what would have been offered earlier.
Therefore, instead of waiting for higher rates they can divide their FDs into different parts and start booking FDs after an interval so that they can average out the interest rate close to peak rates. Another way of ensuring that you never get the lowest rate on your entire FD portfolio is by going for FD laddering. As it will ensure regular liquidity and average yield on your entire FD portfolio.