Fixed deposit investors have been having a great time as interest rates have peaked from historic lows seen till April 2022. However, the good times may not last for too long as the interest rate cycle is about to see a downward trend in the coming days despite the Reserve Bank of India (RBI) holding the repo rate in the sixth consecutive MPC meeting on February 8. While the reversal of the interest rate cycle was largely expected this year, however, many new factors have accelerated the timing of the rate fall.
Here is a look at what FD investors should expect in the coming month in terms of interest rate movement and how they can make the best of the developing scenario.
Softening inflation and higher economic growth to aid RBI in reducing rates in future
Rising global inflation was the primary factor why the Reserve Bank of India (RBI) hiked the repo rate by 2.5% between May 2022 and February 2023. However, inflation has subsided since then and is now below 6%, the upper level of the tolerance zone of the RBI.
“The government has pegged only a moderate growth in non-capex expenditure. This should keep inflation under check and provide enough headroom to the RBI to cut interest rates,” says Pankaj Pathak, Fund Manager-Fixed Income, Quantum AMC.
The Consumer Price Index (CPI)-based inflation went up from 5.65% in November to 5.7% in December. However, core inflation has remained benign and slowed to a 2-year low of 3.9%. "We anticipate headline inflation to remain range-bound around 5-5.2%YoY in 1Q24, due to a faster deceleration in vegetable prices and favourable base effect, and average at 5.4%YoY in F24 and 4.5% in F25," says a Morgan Stanley research report dated January 21.
Reasons why FD interest rate fall is likely to start early
The interim Budget 2024 has provided a new reason for a quicker interest rate reduction. "The lower fiscal deficit figure of 5.1% versus market expectations of 5.3-5.4% has been a positive for the markets," says a note from Axis Mutual Fund. “Furthermore, the lower gross market borrowings is another positive. These coupled with the expected inflows in JP Morgan Indices Index beginning June 2024 will help bring down yields further lower. We expect the Reserve Bank of India to complement the budget with changed stance on liquidity and lower interest rates in the second half of the year."
Bank of Baroda BNP Paribas Mutual Fund says: "The Advanced Economy central bankers came with much stronger rate hikes to curtail inflation as against, say, India where the rate hiking cycle halted at 6.50% (implicit cost of capital). Thus, we expect the rate cutting expectations from RBI to be much shallower into 2024.”
The report expects the RBI to ease the repo rate by 50-75 basis points, taking the rates to 5.75% levels within 18 months.
While many experts were estimating the rate cut to happen in the second half of the year, it is likely to start earlier following the recent development, though at a slower pace. "On monetary policy, we build in a shallow rate cut cycle of 50bps from Jun-24, in our base case, even as we continue to remain watchful of risks from stronger-than expected growth (strong credit growth), which may defer the rate easing cycle," says the Morgan Stanley report.
What bond yields suggest about FD rates in coming months
The yield of 10-year government bond is one of the sound indicators of the interest rate in the economy and the deposit rate typically follows the direction of this yield. The 10-year government bond yield which was trading at 7.20% on January 8 has already fallen to 7.07% on February 7. This fall is likely to continue and experts estimate that this bond yield will fall significantly in the coming months.
"With policy rates remaining incrementally stable, we have retained our long duration stance across our portfolios within the respective scheme mandates. We do expect the 10-year bond yields to touch 6.75% by June - September 2024," says the note from Axis Mutual Fund.
By the end of the year 2024 the rates are expected to fall further. "We remain constructive in our view with a softening bias on interest rates running into 2024. We would add duration incrementally in all the portfolios on a risk adjusted basis. We expect the 10-year G-sec to trade in the range of 6.25%-6.40% by the end of CY 2024," says Bank of Baroda BNP Paribas Mutual Fund in its report.
If this holds true, it will mean that most of the big prominent banks are likely to reduce their long-term FD rates to around 6.5% by the end of this year.
What should fixed deposit investors do?
Whenever FD rates start falling it will be the short to medium term interest rates that will be impacted first. So, if you have surplus funds to invest for the small to medium term (up to 3 years) then you may book now or do it at least within next 2-3 months.
However, there is a different reason why the some FD rates may even rise before final coming down this year. "We’re seeing a consumer mindset shift. From a savings mindset, the consumer is moving to an investing mindset. A consequence of this shift is that more and more consumers are getting straight into mutual funds instead of savings products such as deposits. This is causing a tightening of liquidity with banks, as many industry leaders have highlighted recently. As a result, the expectation is that there will be clamour for short-term deposits with 1-year rates nudging higher and longer-term rates possibly remaining flat. Consumers, especially senior citizens, can avail these short-term rate hikes for better interest earnings," says Adhil Shetty, CEO, Bankbazaar.com.
The impact on long-term FD rates is likely to be slower and also in lower quantum. Therefore, you may get a bigger window to book your long-term FD at current higher rates. However, the longer you wait there will be a higher risk of falling rates.
If you are planning to invest in tax saving FDs, which come with a lock in period of 5 years, the last day to invest will be Mach 31 as it is the last day for doing this investment (i.e., for tax savings) for current financial year FY 2024. You will get one of the highest interest rates these FDs have seen in the last 2-3 years.
Also read: Up to 7.9% interest rate on tax-saving FDs: Latest senior citizen tax-saving FD rates of private, PSU banks
