RBI's move to push up FD rates further: Here's how investors can get the best of it

With RBI hiking the repo rate by 0.50% during the monetary policy meeting on June 8, the repo rate has witnessed a total hike of 0.9% within a short span of 36 days. It clearly signals that good days are finally here for fixed deposit (FD) investors, who had witnessed a 40% decline in FD interest rate from the highest interest rate level of 9% offered by SBI in September 2014 to 5.4% in May 2020 within a period of 6 years. Decadal low FD interest rates was a cause of huge financial stress for people like senior citizens whose primary source of regular income comes from FDs.

Two consecutive hikes of repo rate have reversed the interest rate cycle toward higher rates. A 90 basis points of hike in FD interest rate from 5.5% to 6.4 % means that on each 1 lakh rupee FD for 5 years you will end up getting Rs 5,958 additional interest payout.

Slower transmission of rate hike in FDs

Whenever policy rates start going up it is the lending rates that see quicker transmission while the rate transmission is slower in FD rates. There is usually a lag when the banks start passing on the benefit of a rate hike to the depositors. Another reason for delayed transmission of hike in deposit rate is that banks already have sufficient liquidity and hence competition for deposit is not very high.

However, going forward if the RBI keeps raising rates gradually, banks will be compelled to raise their deposit interest rates as well. Therefore, FD investors should keep this in mind that it may take long after the RBI is done with its series of rate hikes for the depositors to get the entire benefit.

Also Read: FD investors should use this formula to get maximum benefit from rising interest rates

Should you book long term FDs after current hikes?
Though a rate hike is welcome news for depositors, however, it comes with a fair share of dilemmas. Even though the direction of interest rate has reversed, however, nobody is sure where the rates will finally reach and how long will it take for interest rates to peak. If you wait longer to book your FD for a higher rate you will end up losing on current growing rates and if you book long-term FDs after only a few hikes, you may end up at the losing end if the rates keep growing later. We tell you how the interest rate is likely to move and how you can make the best out of the unfolding situation.


When can you expect the FD rates to reach 7%?
With 0.9% interest rate hike within 36 days, many experts feel that there is still a scope of 50-75 bps hike in coming 2-3 quarters. A very robust indicator for long term interest rate is the 10-year G-sec yield which has already crossed the 7% mark. Though the transmission will be slow, the likelihood of bank FD rates crossing the 7% mark in the coming 6-9 months cannot be ruled out.

Will FD interest rates touch the 8% mark?
8% interest is considered to be a decent return by a good number of FD investors. So how likely is the possibility of deposit rates reaching that level? The current situation is extraordinary in many ways due to the Covid-19 pandemic related liquidity infusion by many countries and hyperinflation led by the Russia-Ukraine war. So, the FD interest rates touching the 8% mark is a possibility. As the momentum of the interest rate hike looks strong it is not farfetched to expect the interest rate to reach closer to 8% within 1-2 years.

Should one wait for rates to cross 7-8% for booking long term FDs?
So, if you are looking to book an FD for the long term or a big FD is due for renewal, this may not be the right time to do so. In a growing rate scenario, it is better to book FDs with short tenure so that it can benefit from the hike during the investment period. So, booking an FD with a tenure of 6 months to one year could be a better strategy. Once these FDs mature and you get a better rate at the time of renewal you can book longer term FDs.

How to tweak your FD ladder in the current situation
Making an FD ladder is also an option as it helps you to break a big deposit into many parts and book each part after a time gap so that you get the average return and periodic liquidity when there is volatility in the interest rate. However, choosing the right tenure and frequency of deposit is important. In a rising rate scenario keeping the tenure and gap between deposits low is the key so that the deposit gets the benefit of growing rates quickly at the time of maturity. These can be gradually increased to complete a stable ladder.

For instance, if you have Rs 10 lakh you can the first FD of Rs 2.5 lakh for six months, then a second FD of Rs 2.5 lakh for 9 months and so on. Once your first FD matures you can increase the tenure to 2 years and after that once the second FD matures you can keep the tenure 2 years 3 months and so on. Once these FDs start maturing you increase the tenure to 3 years and increase the gap between the two FDs to 9 months.


Should you invest in RBI floating rate bond?
RBI floating rate bond is another good option to consider as these bonds are designed to pass on the interest rate hike benefit to depositors. In the rising rate scenario, a floating rate deposit can be an apt investment. As this bond comes with a long lock-in period you should invest only an amount which you may not need for the locked in period. However, only those investors should go for it who prefer periodic income and are comfortable with long lock-in period of 7 years.