Options for depositors amidst interest rate cuts

The Reserve Bank of India (RBI) recently cut the repo rate by 50 basis points marking it the third reduction since February of this year, totalling to 100 basis points. This was a huge surprise and a larger than expected rate cut. It is debatable whether such a massive rate cut was justified since inflation had been trending down in the last couple of quarters. RBI itself was convinced that war against inflation had been won. 

While this is good news for corporates and retail borrowers who could see interest rates on personal loans going down immediately, it is not so good news for depositors and senior citizens depending solely on interest income to take care of their expenses. 

What should investors do in a falling interest rate scenario? Let us try to explore the options: 

Banks have already slashed interest rates on savings accounts and fixed deposits (FDs) by 25 to 70 points between February and April this year. They will slash them further after the recent RBI move. 

New FDs

While the existing FDs will not be impacted by the rate cut till maturity, any new FD that you open or renew will have lower interest rates. You need to re-evaluate your investment strategies and quickly lock into the existing rates before they fall further. Some of you may also think of opening FDs with small finance banks which offer higher interest rates and the difference could be in the range of 100 to 150 basis points. Big banks are offering around 6 per cent for deposits of one year tenure.   

Investors could also think of the laddering strategy in a falling interest rate environment. Instead of investing your entire corpus in a single FD, it is advisable to split your corpus into multiple FDs with staggered maturity dates. As each FD matures, you can reinvest the funds at the then-prevailing interest rates. This will mitigate the reinvestment risk and help you maintain liquidity and average returns over time.

Explore alternatives

As mentioned earlier you may think of parking some amount in small finance banks which offer slightly higher rates than the bigger banks. But do remember that your deposit is covered only up to Rs 5 lakh per bank by DICGC. If you are not too worried about following up with many small finance banks, you can spread your deposits across many such banks. Some of you can also think of AAA rated company deposits which offer better interest rates.

For those investors looking for higher returns with liquidity, they can think of debt mutual funds which invest in a portfolio of fixed income securities like money market instruments, bonds, debentures and government securities. While they offer professional management and diversification, they are subject to market risks and do not offer guaranteed returns like FDs. Arbitrage funds which exploit price differences between two markets can give you better returns than pure debt funds can also be thought of if one is willing to take a little market risk. 

The best bet though for you in the current scenario would be small savings schemes like Public Provident Fund (PPF), National Savings Certificates (NSC), and Senior Citizen Savings Scheme (SCSS) which offer higher interest rates and where interest rates are reset every quarter. The next reset will happen by the end of June before which you can lock in your investment at higher interest rates. Senior citizens can think of parking a maximum of Rs 30 lakh in SCSS which offers 8.20 per cent. For those for whom liquidity is not an issue, 7-year RBI floating rate bonds which offer 8.05 per cent is an ideal option. The interest rate is floating & is 0.35 basis points more than NSC rate. The best part is there is no ceiling on the maximum amount. For those who want a shorter tenure, NSCs which offer 7.70 per cent and have a tenure of 5 years would be better.

In the final analysis, the option you choose should be based on your liquidity needs, return expectations, investment horizon and risk appetite.