Given the hike in repo rate, if you are looking at locking money in bank deposits for a longer tenure, it makes sense to do it now.
In order to curb retail inflation, Reserve Bank of India (RBI) increased the repo rate by 25 basis points (bps) to 6.5%, the second such hike this year. The back-to-back rate increase in five years will make all types of loans costly. Depositors, however, will benefit from the rate hike.
In fact, even before the central bank raised the repo rate on Wednesday, the country’s largest lender, State Bank of India, had already raised its interest rates on domestic term deposits (below Rs 1 crore) by 5-10 bps with effect from July 30. While keeping deposit rates of up to one year unchanged, it increased the deposit rate in the one year to less than two years bracket by 5 bps from 6.65% to 6.70%.
For deposits for two years to less than three years and three years to less than five years maturity slabs, the deposit rates rose 10 bps each to 6.75% and 6.80%, respectively. For five-year and up to 10-year maturity, the rate increased by 10 bps. At a time when growth in deposits is slowing, other banks will have to increase rates, especially long maturity deposits.
Fixed deposits to gain
Increase in deposit rates will attract risk-averse investors to park money in bank fixed deposits. It will also prompt companies that raise deposits to increase rates to make the paper more attractive. In fact, company fixed deposits of top-rated firms are much in demand because of volatile equity markets. Company deposits give 50-100 bps higher rates than bank fixed deposits as the risk involved in company deposits is higher. Investors must take an informed decision before investing in company deposits.
Analysts say if one is looking at locking money in bank deposits for a longer tenure, it makes sense to do it now. Also, if an individual is locking money for a long maturity, he must ensure some liquidity for emergencies. Banks will charge a penalty for premature withdrawal and will give the interest rate for that particular period. Banks will also deduct TDS at 10% if the interest is above Rs 10,000 in a year. To avoid the deduction, one has to submit a declaration under Form 15G (Form 15H for senior citizens) stating that his income is below the taxable limit.
Small savings schemes may become attractive
One can look at small savings schemes such as 5-year National Savings Certificates (7.6% interest rate); post office 5-year monthly income scheme (7.3%); 9.4-year Kisan Vikas Patra (7.3%), Public Provident Fund (PPF) (7.6%) or simply a 5-year post office fixed deposit to earn 7.4%.
The interest rate on small savings schemes has been kept unchanged since January this year. In June-end, there was expectation that the government would hike small savings rates marginally, given the rise in bond yields. Interest rates on small savings schemes are linked to government bond yields of similar maturities. A spread, depending on the scheme, is added to the average government bond yield of the previous quarter. Interest rates for small savings schemes are being notified on a quarterly basis since April 1, 2016 as per the recommendation of Shyamala Gopinath committee.
Small savings schemes such as PPF and Sukanya Samriddhi are popular with investors. For individuals, PPF is the most preferred investment option as it is tax-exempt at all stages. A resident Indian can open a PPF account and even a second account in the name of minors, but the maximum investment limit will be Rs 1.5 lakh for all accounts taken together. Deposits in PPF qualify for deduction from income under Section 80C of the I-T Act, where the ceiling is Rs 1.5 lakh a year. The PPF account matures after 15 years and can be renewed every five years thereafter.
Non-residents, however, cannot open a new account, but can continue their existing accounts till maturity, without extensions. While premature closure of account is not allowed, one can withdraw money every year from the seventh financial year onwards. Similarly, Sukanya Samriddhi Account (SSA) enables parents of girl child to build a corpus for her education and marriage expenses. The minimum deposit every financial year is Rs 250 and maximum is Rs 1.5 lakh. Like PPF, an individual who invests in SSA will get tax deduction at the time of investment every year and even the interest is tax free.