Bank FDs and the inflation risk

Adhil Shetty

BankBazaar.com

Bank fixed deposits have traditionally been one of the most popular investment tool used by a vast section of society across all economic zones. With the markets likely to remain volatile till at least the next general election results are declared, the market sentiment is quite unpredictable.

The Reserve Bank of India has given clear signals that it is watching the retail inflation rates closely and any adequate rise in inflation rates would compel it to increase repo rates which would lower fixed deposit rates substantially.

Correlating inflation and fixed deposits rates:  Inflation is the biggest deterrent when it comes to making substantial gain using bank fixed desists. Most people prefer parking their money in bank fixed deposits to counter for the rising inflation compared to saving bank accounts.

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The higher the inflation, the dismal are the returns provided by bank fixed deposits. If you are earning an interest of 8 percent on the money parked in the fixed deposit while inflation is also at the same levels, you are virtually gaining no returns on the money parked in the fixed deposit. On the positive side, a lower inflationary rate can mean better returns for investors parking their funds in the bank fixed deposits.

Repo rates and their impact on fixed deposit interest rates: Inflation is not the only aspect that affects the way bank fixed deposits fix their interest rates. The overall economic market sentiment as foreseen by the monetary policy of the Reserve Bank of India traces the way for the future interest rate trends.

Whenever the RBI brings down repo and cash to reserve (CRR) rates, the loan rates as well as the interest rates on fixed deposits get lowered.  However the final decision depends on the level of liquidity in the financial markets. 

In case banks want to squeeze the level of liquidity in the market, it may offer lucrative interest rates. Usually the interest rates for fixed deposits are inversely proportional to the repo rates.  Most financial experts recommend that fixed deposit investors must explore the option of locking in their money for a long period in case the possibility of a repo rate cut gets imminent.

Repo rates and the road ahead in 2014:  While the Reserve Bank of India has left the repo rates and CRR rates unchanged for the third quarter, the governor of RBI, Raghuram Rajan has clearly mentioned the rising inflation rates as an area of deep concern. According to the RBI report, retail inflation based on the consumer price index surged to an all-time high of 11.24% against 10.17% in October.

Financial experts have also forewarned that such rising inflation rate offers a great risk to the overall economic scenario. In such a case, the RBI is likely to hike key policy rates in the near future. Once such a decision is indeed taken, it could mean a substantial increase in interest rates for borrowers and a reduction in interest rates for fixed deposit holders.

A better than normal monsoon season however along with a positive government in place after the Lok Sabha election scheduled for May or June in 2014 can bring in a positive market sentiment. If both the results are positive, inflation may come under control in the middle of the year which may offer a chance for RBI to offer repo rate cuts leading to better fixed deposit rates.

The author is a CEO at BankBazaar.com