RBI holds repo rate: The time to rejig your FD investments starts now FD investors are much better placed now than a year before however the FD rate hikes have largely been limited to small to medium term tenure. As the full transmission may take some time this may be the right time to rejig your FD investments
When a good number of experts were anticipating a repo rate hike, RBI surprised everyone by holding the repo rate. Fixed deposit investors who were hoping to see further rate hike will be disappointed. The Reserve Bank of India (RBI) has decided to keep the repo unchanged at 6.5% in its bi-monthly monetary policy meeting held on April 06, 2023.Despite RBI holding the repo rate the overall hike within last 11 months stands at 2.5%. The interest rate scenario could not have been any better for the FD investors as just a year before they were struggling with one of the lowest interest rates on FDs seen in last two decades and now, they are anticipating the benefit of all previous big repo rate hikes to be passed on to the bank FDs.
Now, FD investors have certain queries: have FD interest rates reached closer to the peak of the current cycle or will take it some more time? What could be the best time to go for long-term FDs. While the views on the peak rate may vary, however, one thing is sure that this could be the best time for FD investors to rejig their investments. Let us understand the direction in which FD rates are likely to move and what could be the best course for your FD investment.
Has the interest rate cycle reached its peak?
The main reason for the RBI to increase rates earlier was the high retail inflation, however, the retail inflation after falling below 6% in December 2022, went up again to 6.44% in February 2023. RBI would be expecting it to fall below 6%, the upper level of the RBI comfort zone, which may allow the central bank to extend the pause in the hike cycle in the near future. However, unless inflation subsides durably, the likelihood of another repo rate hike cannot be ruled out completely.
The 10-year Gsec yield, which reached 7.59% in June 2022 due to expected future hikes, has not touched that level again and it has witnessed a sharp decline in the last one month from 7.46% on March 8, 2023, to 7.28% on April 5. This shows that the market is expecting the rate cycle to pause.
Most of the world’s central banks have indicated that they are close to finishing their rate increases. Commodity prices, such as crude oil, have largely remained range bound in the last 2-3 months. All these factors imply that we are approaching the highest point of the interest rate hike cycle.
Banks yet to transmit full repo hikes to FD rates
When the repo rate goes up, the lenders quickly charge higher rates to the borrowers, especially for loans with floating rates linked to the repo rate. But they are slow to pass on the rate hike benefits to fixed deposit investors. The RBI data shows that the lowest and highest interest rates of FDs with more than one year tenure were 5% and 5.60% in April 2022. Since then, the lowest interest rate has increased by 1% to 6% and the highest interest rate has increased by 1.65% to 7.25% as on March 24, 2023.
This clearly shows that interest rates on these FDs with more than one year tenure are still far from catching up with the 2.5% repo rate hike during the same period. While the transmission of the highest interest rate has been quite high, the same is not true for the lowest interest rate. This shows that many banks are comfortable with the lowest interest rate and have not felt the need to raise their rates due to competition, which may happen in the coming months.
However, one advantage which banks got in Budget 2023 was removal of tax advantage of most debt funds which is expected to benefiting banks as funds will move from debt mutual funds to bank FDs. However, another factor which will make the situation tough for banks is the hike in the interest rates of small saving schemes to maximum of 8.2% in case of SCSS. This will compel banks to increase their interest rates as well.
FD rates are yet to peak for long tenures
The banks that are offering higher interest rates are only doing so for FDs with medium term tenures between 1 year and 3 years. For example, Kotak Mahindra Bank offers its best rate of 7.2% to general citizens and 7.7% to senior citizens on tenures from 390 Days (12 months 25 days) to less than 2 years. Union Bank of India offers its peak rate of 7.30% on two specific tenures of 800 days and 3 years. PNB offers its peak rate of 7.25% for general and 7.75% for seniors on a specific tenure of 666 days.
Some big banks are also offering their highest interest rates to general citizens only for tenures up to 3-5 years. For instance, SBI offers its peak rate of 7% to general citizens on FDs with tenure from 2 years to less than 3 years. The highest rate of 7% for general and 7.5% for senior citizens is available on tenure from 15 months to 5 years in HDFC Bank and ICICI Bank.
However, if you compare the SBI interest rate of 5.4% on a tenure from 3 years to 5 years available in January 2022, the rise so far has only been 1.6% for general citizens, which is not close to the 2.5% repo rate hike during the same period. Many of these banks are offering their highest rate to senior citizens on longer tenures above 5 years, but not to general citizens. The peak rate of senior citizens for a tenure from above 5 years to 10 years is 7.5% in SBI, 7.75% in HDFC Bank and 7.5% in ICICI Bank. However, here too, the transmission is not close to 2.5%.
The historical trendline of interest rates of various tenures shows that all the rates are getting closer to the 10-year Gsec yield, which is currently between 7.3% and 7.5%.
Is this the best time to book your FDs?
Most of the key factors suggest that we are near the peak of the current repo rate hike cycle. While the repo rate hike cycle may be almost over with the latest hike, the rise in FD interest rates may continue for some more time. Not all banks have increased their FD interest rates in line with repo rate hikes, especially for FDs with long tenures. It will take some time for the banks to raise their rates further. Next monetary policy scheduled in June this year will give a more tangible direction which these rates will move in going forward.
What should you do in the current scenario?
If you want to invest in a large FD for a long tenure, it may be better to wait for 2-3 months. However, you can also split your FDs into 2-3 parts and invest one part now and the rest after 3 months. If you want to create an FD ladder, this may be the best time to start.
For example, you can divide your principal into three parts and book each one for one year, two years and three years, respectively. Next year, when the one-year FD matures, you can reinvest it for three years and do the same the following year when the next FD matures.
If you have an old FD for a long tenure that is earning a very low interest rate, then this may be the right time to break it and reinvest it if the remaining tenure is long. However, you need to do the net benefit analysis before taking this step. The interest rate transmission in smaller private banks and small finance banks has been faster and they are offering much higher rates than bigger banks. So, if you want to take advantage of higher interest rates in these banks, which have a higher risk element, you need to make sure your exposure is well-covered under the Rs 5 lakh deposit insurance cover from DICGC.
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This story originally appeared on: India Times - Author:Faqs of Insurances
