Fixed & Faithful

Retail investors in India have always preferred to invest money in fixed deposits and banks are now wooing them with renewed zeal,offering higher interest rates. In the last one year,both public and private sector banks increased their deposit rates by over 100 to 150 basis points depending on the tenure of the deposits. Investors are finding it profitable to invest in short maturity periods of,say,61-91 days and 91-179 days,as they expect deposit rates to rise further in the near term.

With headline inflation touching 8.43% in December and the central bank expected to raise policy rates further to contain inflation,investors can hope to see banks offering even higher rates to win fixed deposits.

In the next one year,deposit rates are only going to rise given the macro-economic factors in the country. It makes sense for investors to go for short-tenure instead of long-tenure term deposits for say three years and above, says a senior banker with a leading public sector bank. He says since the minimum investment for a fixed deposit is Rs 1,000,investors can choose a combination of various maturity tenures depending on the need for cash flow to enjoy higher returns. Data from the Reserve Bank show that bank deposit growth has grown by about 25% in the current financial year,indicating investors’ preference of this safe avenue.

Risk-averse Indians find safety in the fixed deposits of reputed banks and financial institutions which are regulated by Reserve Bank of India (RBI). Deposits up to Rs 1 lakh are guaranteed by the central bank and the investor will get back the money in case the bank defaults. Moreover,fixed deposits earn fixed interest rates for their entire tenure and in most cases,are compounded quarterly. As a result,many households who do not have any other source of income and want some money flow on a regular basis invest in fixed deposits and earn the interest income. This mode of savings is very popular with retirees,who get 25-50 basis points more interest than the normal category.

Bank fixed deposits also give tax benefits as investment of a maximum of Rs 1 lakh for 5 years is eligible for tax deductions under section 80 C of Income Tax Act. This is the same section where an investor gets exemption for premium paid for life insurance,post office national savings certificate,equity-linked savings scheme of mutual funds,employees provident fund,New Pension Scheme and public provident fund. However,the interest earned on fixed deposits is fully taxable and is added to the annual income of the individual.

Investors must note that in tax-saving fixed deposits,the lock-in is for a period of five years and one cannot withdraw the money nor can it be pledged for any loan during the tenure. Moreover,the tax-saving fixed deposits do not have any sweep-in facility which means that the fixed deposit cannot be linked to a savings account and the surplus funds available under the savings account cannot be automatically invested in this fixed deposit. An investor does not get any overdraft facility on this deposit.

However,general term deposits of banks score well on liquidity. In case of any emergency where the investor needs money,he can break the deposit after paying a penalty of 1-2% depending on what the bank charges. The penalty rate comes down as the investment moves closer to the maturity date. However,some private sector banks do not allow withdrawal of deposits in the first three months for deposits of over two years of maturity. An investor must carefully calculate the penalty charges the bank will levy for early withdrawals.

Rising interest rates and the liquidity crunch in the banking system have also seen a host of private sector companies tapping the corporate deposit market offering higher interest rates than banks. However,company fixed deposits are not considered as safe as bank fixed deposits and investors need to check the credentials of the company and its credit rating. Corporate deposits are not as liquid as bank deposits and in most cases do not pay any interest if the money is withdrawn before maturity. So,in a rising interest rate regime,investors will find it profitable to invest in bank fixed deposits.