The RBI first hiked the repo rate by 40 basis points in May. Following the five successive hikes between May and December, the repo rate has gone up from the 4% (before May) to 6.25%. Alongside, with credit growth outpacing deposit growth, banks have been raising their deposit rates to attract more depositors.
With the leading private sector lender HDFC Bank offering as high as 7% per annum on many of its deposits, the bar has been set high for other smaller banks. Many investors tend to shop for higher FD rates across banks and sometimes go for banks that have a smaller deposit base, or not the best of financials but higher interest rates. That argument does not hold true today with one of India’s largest banks setting a high threshold. The AAA-rated deposits from well-established NBFCs offer yet another point of comparison. Take for example Sundaram Finance which offers 7.15% on its 1-year and 2-year, and 7.30% on its 3-year cumulative deposits- not significantly different from the FD rates of leading banks. Another well-known NBFC, Bajaj Finance offers rates ranging from 7.05% to 7.95% on cumulative deposits ranging from 1-year to 5-year tenures. The highest rate of 7.95% is offered only on its special 44-month deposit, and the next highest rate offered is 7.75%.
Now and then
HDFC Bank revised its deposit rates on December 14, and currently offers its highest rate of 7% on its deposits of 15 months to up to 10 years. Note that, other leading private sector banks such as ICICI Bank and Axis Bank too are offering this rate. ICICI Bank is offering 7% on its 15 months to up to 5-year deposits, beyond which the rate is a tad lower at 6.9%. Axis bank is offering 7% on its 2-year to up to 10-year deposits. All these rates are applicable on deposits of below Rs. 2 crore.
If we go back to April, that is, before the RBI’s rate hikes began, the highest rate that HDFC Bank and ICICI Bank were offering was 5.45%, and Axis Bank, 5.75% on their deposits of tenures ranging from one year to up to five years. In fact, even if we take into account all the scheduled commercial banks, both from the private sector and the public sector, the highest rate offered on FDs of such tenures was only 6.5%. This is basis data compiled by BankBazaar for deposits of select maturities (up to 5 years only).
Investing in 1-2-year deposits
With the prevalent deposit rates looking attractive, should you invest in the 1-2-year FDs from leading banks? While such FDs can fetch you rates as good as the longer tenure deposits (possibly even better in some cases), they can expose you to re-investment risk. That’s because once these FDs mature within a year or two, you will have to explore other options for re-investing this money. Depending on where interest rates are at that point in time, you could end up with a better or worse off deal. While it’s tough to predict with precision where interest rates are headed, Anil Gupta, Senior Vice President & Co Group Head - Financial Sector Ratings, ICRA offers some guidance. “FD rates have not yet reached pre-covid levels. There is headroom for further rate increases as the banking system liquidity may become tighter in the coming months. This coupled with the expected rate hike by the RBI in February 2023 may prompt banks to further raise deposit rates by 50-75 basis points in coming months." However, the situation could be very different a few years (as compared to only a few months) down the line. So, while the 1-2-year FDs may offer attractive rates, the re-investment risk is something worth considering.
Debt funds as an alternative
In fact, if you do have a longer investment horizon (3 years or longer), debt funds may be a better post-tax option for you. This is especially so if you are in the higher income tax bracket of say 20% or 30%. That’s because if you remain invested in a debt fund for 3 years or longer, your return (long-term capital gains) gets taxed at 20% with indexation benefit. This can significantly reduce your tax liability.
Of course, unlike returns from FDs which are fixed, those from debt funds are market linked. Interest rates movements between the time of your entry and exit from an open-ended debt fund can impact your return. The one way to get around this to a large extent, is to invest in target maturity funds (TMF). These are debt funds with a defined maturity and high credit quality that offer a reasonable degree of return predictability (indicative return is known at the time of investing) to those who remain invested until the fund matures. A TMF passively invests in the bonds of a particular index and has the same maturity as that of the index that it tracks. The fund’s yield to maturity (YTM) at the time of investing minus the expense ratio gives your indicative return. Take for example, the TMFs from Edelweiss MF for which daily updated YTMs are readily available. These are offering YTMs of 7.37% to 7.45% for funds with a maturity of 3.5 to 4.5 years. With several mutual fund houses offering a wide range of TMFs – with varied maturity and portfolio composition - investors have enough options to choose from in this space.
Deposits for senior citizens
That said, when it comes to senior citizens, bank deposits can still be an attractive choice. Take the case of HDFC Bank which offers 7.75% to senior citizens (60 years and above) on deposits with a maturity of 5 years 1 day to 10 years. If you are a senior citizen with a corpus of Rs. 1 crore, then you can earn an interest income of Rs. 7.75 lakhs every year for the next 10 years. Assuming you are under the old tax regime and have no other income, your tax liability (including health and education cess) will come to Rs. 67,600 per year, that is, an effective tax rate of only 8.7% (see table). This is based on the tax calculator on the Income Tax website.
