Why fixed deposits are likely to give better returns after RBI’s rate hike

The recent hike in the repo rate by the RBI has given a good reason to smile to the people who invest in fixed deposits. The central bank increased the repo rate by 0.25% from 6% to 6.25% in its second bi-monthly meet of the Monetary Policy Committee on June 6. This move comes after a gap of more than 4 years when the central bank last raised the repo rate. Many banks of late have raised their deposit rates. With the RBI’s hike, the trend of rising interest rate has been formally established. More banks are likely to follow suit and hike their FD rates further.

The yield of 10-year bond, a good indicator of the direction of long-term interest rate in the economy, went up from 7.834% on June 5 to 7.917% on June 6 after the RBI announcement. It continued its upward movement on Thursday and is standing around 7.975% at the time of reporting. However, there was a contrary movement on short-term interest rates as it faced a marginal decline. The weighted average call money rate, which is a good indicator of short-term liquidity and interest rate in the economy, came down to 5.88% on June 6 from 5.89% recorded on the previous day.

This hike is unlikely to push the short-term interest rate. A greater impact will be on long term interest rates. “Besides increasing the repo rate the RBI also relaxed the LCR (Liquidity Coverage Ratio) for the banks. The central bank has now allowed 2% additional securities of the banks to be counted as SLR. This means that banks will now have extra liquidity to lend to the customers. Therefore, while the long term rates have gone up the short term rates have actually eased after the policy.” says Mahendra Jajoo, Head-Fixed Income, Mirae Asset Global Investments (India).

However, if the global economic condition remains somewhat similar and if the crude oil price does not cool down significantly in the near future, the FD rates in India may rise marginally. “Lending is not happening for the banks at great pace as they are dealing with NPA issues. So, the banks will not be in a huge rush to increase the fixed deposit rates. As the RBI stance has also been neutral so I think the banks will increase the FD rate maximum by 25 basis points in next 3 months.” adds Jajoo.

At present the highest interest rates on FDs of 5-years tenure offered by banks in India have been in the range of 7% – 7.35%. Whenever the central bank raises the rates there is higher level of transmission of the hike in overall banking system as banks raise their interest rates both for lending and deposits, while the contrary may not be always true when the RBI cuts the rates. Hence, we may see higher transmission in the current scenario and interest rate of FDs with long term tenure may reach in the range of 7.25%-7.5% within next 3-6 months.

This would bring cheer to senior citizens who primarily depend on fixed deposits to meet their regular income requirements. Since many banks offer a 0.25-0.5% higher interest rate to senior citizens so they can expect the FD interest rate to touch the 8% level after a long gap.

There are many factors including higher crude oil prices, higher interest rate in US, rising domestic inflation which have led to the RBI decision. With primary objective of keeping retail inflation around 4% the RBI has increased the repo rate for sucking some liquidity from the system and cooling down the retail inflation. Going forward if the crude oil price cools down significantly and monsoon goes normal as predicted by Meteorological Department (IMD) we may see a stagnation of the interest rate or even a minor reversal.

Source: BT

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