The Reserve Bank of India (RBI) is known for its monetary policy that plays a pivotal role in governing the Indian economy. Interest rates are a crucial part of this policy that impacts the returns on fixed deposits (FDs) in India. Recent changes in the RBI’s policy have led to significant fluctuations in FD interest rates, leaving investors wondering about its impact on their portfolios.
FD interest rates are the primary source of income for many investors, especially retirees, who are risk-averse and prefer capital preservation. These rates are determined by various factors, including the RBI’s monetary policy, inflation, liquidity in the economy, and other market forces. Therefore, any changes in these factors can have a substantial impact on FD interest rates.
The RBI’s policy on interest rates has been accommodative in the recent past owing to the pandemic’s impact on the economy. In March 2020, the RBI cut the repo rate by 75 basis points to 4.4% to support the economy during the Covid-19 pandemic. The repo rate is the rate at which the RBI lends money to commercial banks. The reverse repo rate, the rate at which banks park excess money with the RBI, was cut by 90 basis points to 4%.
These policy changes had an immediate impact on fixed deposit interest rates as banks reduced their deposit rates to align them with the lowered lending rates. The average FD rates for one to two years of tenure reduced from 6.5% to 5.5%, as per the RBI website. The State Bank of India, the country’s largest bank, reduced its FD rates by up to 50 basis points in March 2020. Other banks followed suit, with most of them announcing rates of 5%-6% for one-year FDs.
However, this trend reversed after the economy stabilized and inflation picked up. Inflation rose from 4.6% in October 2020 to 6.3% in May 2021, which prompted the RBI to undertake policy measures to curb it. In June 2021, the RBI kept the repo rate unchanged at 4% and indicated a shift towards a tighter monetary policy to address rising inflation. The RBI also lowered the GDP forecast for 2021-22 to 9.5%, from the earlier estimate of 10.5%.
These policy changes have led to a reversal in FD interest rates once more. Banks have started to increase their deposit rates to attract more capital and align them with the rising lending rates. SBI recently raised its FD rates for select tenures by up to 10 basis points. Smaller banks like IDFC First Bank and Federal Bank have raised their FD rates by 75-100 basis points to attract more deposits.
Investors must evaluate the impact of these policy changes on their FD portfolios and explore other investment options to diversify their holdings. One must consider the inflation-adjusted returns as well while investing in FDs. As inflation rises, FD interest rates may not suffice to provide significant real returns.
To illustrate, consider a one-year FD investment of Rs. 1,00,000, with an interest rate of 6%. At the end of the year, the principal amount and interest earned will be Rs. 1,06,000. However, if inflation is at 6%, the real value of the investment will remain the same. The return will only be nominal, not real. Hence, investors must consider the inflation rate while calculating the ROI on FDs.
On the flip side, the fixed interest feature of FDs ensures capital preservation, making it a suitable option for risk-averse investors. As compared to market investments like equities, FDs do not include significant market risks and provide a stable return on investment. Moreover, FDs are FDIC-insured and offer additional tax benefits for senior citizens in India.
The Fixed Deposit Calculator is a financial tool designed to estimate the potential returns on a fixed deposit investment. Users input parameters such as the initial deposit amount, interest rate, and investment tenure.
Conclusion
The RBI’s policy changes have a direct impact on FD interest rates in India. Recent policy changes have led to a fluctuation in FD rates, with banks raising their interest rates once again. While FDs offer a stable return and capital preservation, investors must consider inflation-adjusted returns and explore other investment options to diversify their holdings. One must carefully gauge all the pros and cons of trading in the Indian financial market before making any investments.
Summary:
The RBI’s monetary policy plays a crucial role in determining the fixed deposit (FD) interest rates in India. Recent policy changes have led to a fluctuation in these rates, with banks raising their interest rates once again. While FDs offer a stable return and capital preservation, investors must consider inflation-adjusted returns and explore other investment options to diversify their holdings. It is imperative to gauge all the pros and cons of trading in the Indian financial market before making any investments.
