Why FD rates falling now

By Rajesh Choudhury

India is currently undergoing a crisis both in health as well as wealth. As per a recent survey, about 95 per cent of households prefer to park their money in bank deposits. Mutual funds came at sixth place (9.7 per cent) followed by stocks (8.1 per cent), pension schemes, company deposits, debentures, derivatives and commodity futures (1 per cent) as investment vehicles for the urban households.
We have been hearing rate cut by the Reserve Bank of India (RBI) most often after the onset of COVID-19. The question is how it is going to affect most of the people who have parked their money in banks. Effective from May 27, 2020, the 1-2-year FD rates have come down to 5.1 per cent from existing 5.5 per cent.
Fixed Deposits and saving deposits rates are governed by the RBI rates, which are repo rates. Several macroeconomic factors influence the repo rate to reduce and banks follow the measurements and reduce the interest rates on fixed deposits and saving accounts.
Since the onset of the pandemic in India, a lot of macro factors affected the liquidity in the market and RBI infused a lot of money — the result is the reduction of interest rates.
Repo rate is the rate at which the central bank lends money to commercial banks in the event of any shortfall of funds. Monetary authorities use this to control money supply in the economy, and hence inflation. The reverse repo rate is the rate at which RBI borrows funds from commercial banks. It is the rate at which commercial banks in India park their excess money with RBI usually for the short term.
Let me explain in lucid language citing with individual reason and the impact on the money parked in the banks in the form of FDs or saving account.
1. Liquidity: The prevailing liquidity in the market or a county plays a very vital role in deciding FDs rate etc. If there are enough ideal cash or Government support in the form of cheap loan to banks then the interest rates get reduced as they don’t want deposits from the general public.
In the current situation, a lot of liquidity is coming from the RBI in the form of package for banks and other sectors and the resultant is the huge decline in repo rate gradually the bank interest rate is also getting declined.
Last May, the FD rate was 7 per cent and now it came to 5 per cent effective from May 27, 2020.
2. Inflation rate: RBI controls the inflation of our country, if there are too much money and utilisation of such money is not in an optimum way, the resultant will be inflation in the county. RBI will intervene and reduce the rate cut further to control the inflation.
3. Weak Economy: Since 60 days or lockdown has arrested the economical activity of the whole world and India is also not spared. The requirement of the fund by the business houses in several sectors is also being reduced. The defaulter’s gap is increasing. Demand for money is also reduced in the economy by those and resultant the ideal money. The effect will be to the end investor of FDs and Saving account holders.
4. Demand and Supply: If there is less demand of credit in the market, consequently the rates of fixed deposits will fall as margin falls.
Fixed deposits (FD) are ideal for investors with a low risk appetite looking for assured returns. Fixed deposits allow investors to deposit their money for a specific period of time for a rate of interest which is typically higher than what is offered for a savings bank account.
With the interest at 2.75 per cent and the annual inflation hovering at around 4 per cent, the real returns you are getting now are actually negative.
During the period of 1990s the fixed deposit holders earned a handsome return of 10 per cent to 12 per cent.

(The author is a certified
wealth manager)

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