Rising interest

Unrelenting inflation also brings with it a measure of respite-the Reserve Bank of India hikes the key policy rates, which leads to banks raising the interest rates on fixed deposits (FDs)

Tanvi Varma/Money Today        Print Edition: February 2011

Every time you look at it, your eyes widen, your heart beats faster, your palms sweat and you feel faint. Yes, we know, a food inflation number of 18.32% does tend to have this rather staggering effect. General inflation continues to hover arouns 8.5% and predictions of it continuing to gallop unabated must be adding to your stress. But amid all the gloom and doom, there is a glimmer of hope for investors.

Unrelenting inflation also brings with it a measure of respite-the Reserve Bank of India hikes the key policy rates, which leads to banks raising the interest rates on fixed deposits (FDs). In the past year, the RBI has increased the rate six times and is expected to do so again, possibly within the next few weeks. This means that banks will once more raise their FD rates. So, if you are planning to invest in a bank fixed deposit, hold for a while to get a better deal.

Analysts expect the RBI to increase rates by one percentage point (100 basis points, or bps). "We could see a rise of at least 50 bps in fixed deposit rates by March 2011 and perhaps a total of 100 bps over the next two quarters. State Bank of India (SBI) could soon be offering a 10% rate of interest on a quarterly basis on its deposits," says Ritesh Jain, head (fixed income), Canara Robeco Mutual Fund.

In fact, in the past few months fixed deposit rates have moved up by almost one percentage point. Preempting a rise, many banking and non-banking financial institutions are already offering fixed deposit rates of more than 9% on deposits with tenures of one, two and three years. IndusInd Bank, for instance, is offering 9.5% on 400- and 999-day deposits. IDBI Bank is offering 9% on 500-day deposits, while State Bank of India is offering the same rate on its 565-day deposit. Interest of 9.25% is being offered by State Bank of Patiala on 1-year deposits, by State Bank of Bikaner on 2-year deposits and by HDFC Bank on 33-month deposits.

Most investors may not be enthusiastic about investing in FDs even if they come packaged with such high interest rates. With inflation at 8.5%, the real returns from debt investments are negative. For instance, an FD bearing an interest rate of 9% works out to a return of just 6.3% post tax (if you are in the highest tax bracket). Your money is losing its value considering inflation is higher than your return. This has been the case for some time considering the inflation index has inched up from a low of 1% in September 2009 to 11% in April 2010, and is currently hovering around 8%.

9.5% is the maximum interest rate that banks are offering on their fixed deposits currently.
So, what are the other interest rate-linked investment options that you could explore? "While FDs may suit you, more so if you are in the lower tax bracket, investors with an investment horizon of more than a year could also put their money in fixed maturity plans (FMPs) over the next two months, considering the higher rates," says Jain. If FD rates are revised upwards, we will also see an increase in returns given by FMPs.

Typically, these track commercial deposit rates, which are currently about 9.5%. If one accounts for expenses at 0.25%, you could get 9-9.5% returns on such products. You could also consider investing in company fixed deposits. Shriram Transport Finance, for instance, has raised the interest rate on its 3-year bond to 10.75%, compounded on a yearly basis. If one were to take a cumulative option, the net yield would be 11.94%. There are other offerings available on this platform.

However, don't rush to park your savings in bond funds right now as yields are still volatile. "Only when you feel that the short-term rates have topped off should you invest in short-term income funds as that is when you will have the opportunity for capital appreciation," says Jain. As interest rates are still on their way up, this could take time. You will then be able to shield yourself better against the malaise of inflation.

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