Bank Fixed Deposit Rates Down, Down, Down. Here Is An Option
Bank fixed deposit rates have fallen significantly over the past two years. And they are set to fall further, with the new RBI chief Urjit Patel making a 25-basis-point cut in repo rate in his first monetary policy.
Hopes of further rate cuts from the RBI have risen on expectations that inflation could soften further in the coming months. The recent cuts in small savings rates could also nudge banks to lower deposit rates.
“The repo cut along with the modest reduction in various small savings rates, would nudge banks to lower their deposit and, in turn, lending rates,” rating agency ICRA said in a note. Brokerages see the RBI reducing repo rate by a further 25-50 bps this fiscal year which ends on March 31, 2017.
In total, the RBI has reduced rate by 175 basis points since January 2015. And according to wealth advisory firm Outlook Asia Capital’s estimates, India’s biggest lender State Bank of India has lowered its one-year fixed deposit rate by 135 basis points during the period.
The RBI’s rate cuts have, on the other hand, benefitted those who had invested in debt mutual funds, particularly in medium- to long-term government/corporate bonds.
According to Value Research, the average annual return in mutual funds in the gilt or government bonds (medium- and long-term) category is 12.5 per cent in the past one year and 12.2 per cent in past three years.
The return in the dynamic bond category is around 11 per cent in the past three years. Dynamic Bond Funds invest in debt securities of different maturity profiles depending on interest rate view of the fund managers. These actively managed funds Invest across all classes of debt and money market instruments with no cap on maturity or duration or types of instruments.
Analysts are hopeful that the rally in debt markets will extend further on expectations of further RBI rate cuts and strong foreign inflows into Indian debt markets amid global gush of liquidity.
Interest rates and bond prices are inversely-correlated, implying that when rates fall bond prices or NAV of debt mutual funds go up.
“”Our estimate is that the next phase of rate cuts will have bigger impact on the market-linked rates (10-year government bond yields) and we expect that in the next 12-15 months, market-linked rates will move down further by at least another 100-125 bps from here. This would imply that further investments in duration based funds would be a strong investment case with a horizon of at least 12-15 months, if not more,” said Manoj Nagpal, CEO of Outlook Asia Capital.
Debt mutual funds are also income tax-efficient compared to bank fixed deposits, particularly for those in higher tax brackets.
Vidya Bala, head of mutual fund research at Fundsindia.com, said that in the current environment investors could look at investing in debt mutual funds that have an average maturity of five to eight years. Or they are better off putting money in dynamic bond funds where the fund manager actively changes the bond portfolio, depending on the interest rate outlook, she added.
Apart from falling interest rates, the tax factor is also one of the reasons why financial planners suggest systematic withdrawal plans (SWP) in debt mutual funds to be a better option for investors – particularly those in higher tax brackets – looking to earn a regular income from a lump sum.