It's time you locked into a long-term fixed deposit

A reduction in key policy rates in the next couple of months is almost a given now. Or so it appears from the reduction in short-term fixed deposit (FD) rates banks have started effecting.

Last week, state-owned Allahabad Bank and private-sector Karnataka Bank cut their deposit rates on FDs of up to two years by 10 basis points (bps) and 25 bps, respectively. Though relatively modest, the reductions signal a trend that is expected to become more visible with more banks following suit.

“We are looking at reducing the rates on term deposits immediately,” said a senior official of Indian Overseas Bank, requesting anonymity. “In the coming weeks, we will see many public- as well as private-sector banks cutting their short-term deposit rates.”

"But deposit rates for long-term FDs will be kept untouched for the time being,” said an official from Indian Bank, also requesting anonymity.

The move could be a precursor to a reduction in lending rates, which is expected to ensue once the Reserve Bank of India cuts the repo rate, or the rate at which it lends to banks. A reduction in deposit rates at this stage could help bring down the cost of funds for banks, ensuring that they do not take a hit on margins when the lending rates are reduced.

“Cheaper credit for borrowers is also on our agenda. But for that, deposit rates have to reduce first in order to maintain a decent margin,” said the Indian Bank official.

For the record, the State Bank of India (SBI), India's largest lender, had in September cut the rates on retail term deposits up to one year by 100 bps and on longer tenures by 50 bps. As per data released by the RBI for the fortnight ended November 2, bank credit grew 16.21% year-on-year to Rs48.59 lakh crore, while deposits grew a sluggish 13.74% to Rs64.35 lakh crore.

Still, lenders are expected to go slow on deposit growth, particularly short-term deposits, where the demand is higher. At this juncture, it does not make sense for banks to increase their liabilities disproportionately by accepting such deposits in a big way.

That is precisely why it makes sense to put money in long-term FDs now. On the one hand, you get to lock into the higher rates prevailing now; on the other, you avoid the risk of reinvesting at lower interest rates in the future.

“After 17-18 months, interest rates are expected to be down by as much as 2%. So when your FD comes up for renewal, there will be a reinvestment risk for the deposit holders. Even if short-term deposits offer 1% more returns, it's better to park your money in long-term FDs,” said Jayanth Vidwans, president of the Society of Financial Planners.

On the other hand, those looking to borrow would do well to wait a little longer. As lenders look to improve their retail credit portfolios, a reduction in lending rates could come sooner than expected.

The Reserve Bank of India (RBI) had in its second-quarter policy review on October 30 reduced the cash reserve ratio (CRR) by 25 bps to 4.25% — a move expected to infuse Rs17,500 crore of primary liquidity into the banking system. The reduction gives banks some elbow room to deploy funds for lending.

CRR is the amount of funds that banks need to keep with the central bank as a certain percentage of their time and demand liabilities.

“We will be concentrating less on our deposit growth and plan to expand our retail advances going forward,” SBI chairman Pratip Chudhuri had said after announcing the bank's second-quarter results on November 9.