Fixed deposits: Three pointers to resolve the dilemma of peak interest rates

FD rates are close to their peaks, it might be a good time to begin locking in the money earmarked for FDs

After several years of not-so-great fixed deposit rates, depositors are having a good time. With the Reserve Bank of India having hiked the repo rate by a total of 250 basis points in the past year, FD rates have moved up significantly. Now, depositors face two dilemmas:

• Whether the repo rate – and as a result, FD rates – is close to its peak in the current cycle or could increase further, and
• Whether now is a good time to lock in high rates in FDs for the long term.Will (repo) rates move up further?

But is that it? Are we at the peak repo rate?

The answer is: We don’t know. And to be fair, the RBI has indicated only a pause on interest rates for now, and not a pivot (or reversal). Depending on inflation and other data in the near future, its stance may change.

But there are signs that if not at the peak, the repo rate might be very close to one – barring unexpected or chaotic global events.

One must understand that when banks decide FD rates, the repo rate is not the only factor. Credit demand growth, deposit growth, the bank’s own time-based asset-liability profile, and overall liquidity are also considered.

This is why FD rates haven’t increased as much as the repo rate. The FD interest rate on two-year deposits by State Bank of India, the country’s largest lender, was 5.1 percent in early 2022 and about 7 percent in May 2023. That’s an increase of 190 bps, which is less than the repo rate increase of 250 bps.

Banks are generally never in a hurry to pass on the full benefit of rate hikes to depositors, not as much as they are in passing it on to borrowers. But if credit (loan) demand is robust, then banks will necessarily want to raise more deposits from the public (via FDs, etc.) and they may then increase rates to attract more deposits and meet the increase in credit demand.

Given that credit demand is still sufficiently reliable, banks may increase FD rates to gather more deposits even if the repo rate stays the same. Therefore, we can say that even if we are not at peak FD rates, we might be quite close.

So, what should you do?

Lock in now or wait?

Given that FD rates are close to their peaks, it might be a good time to begin locking in the money earmarked for FDs, or at least part of them, in sufficiently long FD tenures.

It is entirely possible that the repo rate and bank FD rates may increase a bit more. But it is also possible that it may not happen at all. You can never be sure.

And as soon as the peak is reached, it’s only a matter of time before rates start reversing. So, if you try to perfectly time the rate cycle, you may end up missing the peak completely.

Most large banks currently offer FDs at 7 percent or near-about. The rates offered by smaller banks are even higher. Historically, these are already decent FD rates.

Also read: SIPs work for debt funds, too. And, they beat bank FDs. Here’s the proof

What should depositors do?

If you have been waiting on the sidelines, trying to guess whether FD rates have peaked, wait no more. Start deploying your money earmarked for FDs now.

Here are a few pointers to get you going:

• You can go for FD laddering in three parts. Say you have Rs 25 lakh to be deployed in FDs. Consider deploying 60-75 percent, or Rs 15-18 lakh, in five-year FDs and lock-in the high rates over the next one to three months. The rest can be split into two parts of Rs 3-5 lakh each to be deployed in FDs of one and two years, respectively. This tenure-laddering gives you a chance to earn better returns in a rising rate environment and helps manage liquidity requirements in an optimised way.
• Where to make your FDs? In the bank offering the highest interest rate? No, it’s not that simple. More so if you have a large amount in FDs. As I wrote in this article about things FD depositors need to be careful about, if you have a large amount (more than Rs 5 lakh) to deposit, spread your FDs across a few banks. Put 60-70 percent in RBI-identified systematically important banks. The remainder can be parked in other banks, which may seem attractive as they may offer higher rates.
• And what should one do about old FDs at low rates yet to mature? If the FD matures in a few months, don’t go for premature liquidation – you will lose out on interest and pay a penalty. Let the FDs mature and you would still get reasonably high FD rates to lock-in for new FDs you make later. Go for premature FD closure only if there is a large gap between the new rates and the old rates on existing deposits and also, if a sufficiently long time is left in the tenure of the old FD.