Get a fix on bank deposits

Get a fix on bank deposits

Depositors will closely watch today's credit policy by the Reserve Bank of India.

As real interest rates turn positive and gold price corrects further,investors might park money in long-term bank Fixed Deposits (FDs)

Depositors will closely watch today’s credit policy by the Reserve Bank of India (RBI) as it will give them some traction on interest rates. Though the central bank had stated in its March review that the headroom for any further monetary easing remains limited,lower wholesale price index,coupled with continued weak economic growth,will give some leeway for further easing of rates.

For depositors,throughout 2011-13,high inflation has pushed down real interest rates to negative,which reduced the incentive for consumers to save and invest in bank deposits. And a part of the savings has,instead,gone into gold and real estate. Data show that household savings fell to 22.3% of the GDP in FY12 from a peak of 25.2% in FY12 and savings in financial products dropped to 8% of the GDP in FY12 from 12% in FY10.

The drop in WPI to 6% year-on-year in March means the real interest rate — measured as policy rate minus WPI inflation — has begun to turn positive. As real rates rise,investors will now have the incentive to deposit money in bank fixed deposits.


Also,if gold price declines,says Dutsche Bank in a research note,a substantial shift from the zero yielding asset to deposits with positive real rate of return could take place. The report says there has been a substantial downside to inflation and the likely phase of deflation this year would be greater than the expected decline in the policy or effective rate. As a result,the real interest rate would be rising through the course of this year.

The correction in gold price has been detrimental for investors who bought gold at peak prices as a hedge against inflation. The consumption demand for the yellow metal is likely to decelerate due to slower income growth and the improving real returns on bank deposits as easing inflation will also help to dampen demand for gold.

A HSBC study shows that while gold imports are positively correlated with real rural wage growth,it is negatively related with the real deposit rates,implying that a decline in real deposit rates leads to a rise in gold imports. Also,gold imports are negatively related to the price of gold,meaning that volume demand is indeed price sensitive.

Analysts say if one is looking at locking money in bank deposits for a longer tenure,it makes sense to do it now. In fact,over a month ago,the State Bank of India (SBI) raised interest rates on term deposits by 25 bps for one-year to 10-year tenures. Interest rates,which were earlier 8.5% on all these maturity baskets,are now a uniform 8.75%. Though private sector banks have not increased their rates,analysts say with deposit growth remaining under pressure,banks may not tinker much with interest rates.

For senior citizen deposits,most public sector banks have started cutting the additional interest (or premium) they pay on fixed deposits of these citizens. The move comes after after the finance minister’s observation at a meeting with heads of public sector banks in November last year that the additional interest for senior citizens may be reasonable,but not excessive. SBI reduced the premium on senior citizens’ fixed deposits from 50 bps to 25 bps last month and a week later PNB followed suit.

Given that gold prices are getting volatile and real interest is turning positive,analysts say depositors should build a ladder of fixed deposits with different tenures. “By taking this approach,a prudent depositor can reduce the risk of locking in money for long periods at low rates as bank fixed deposits are prone to uncertainty because interest rates tend to move in multi-year cycles,” says Gagandeep Singh,an independent financial advisor.

Also,if you are locking money for a long maturity,ensure that you have some liquidity for emergencies. Banks will charge a penalty for premature withdrawal and will give the interest rate for that particular period,which will reduce your returns.

Banks will also deduct TDS at 10.3% if the interest is above R10,000 in a year. To avoid the deduction,one has to submit a declaration under Form 15G (Form 15H for senior citizens) that your income is below the taxable limit.