The Reserve Bank of India (RBI) on June 6 cut the repo rate by 25 basis points to 5.75%, as growth impulses have weakened significantly. The country’s economic growth has slipped to a 20-quarter low of 5.8% in January-March 2019, with both consumption and investment engines sputtering. Even on the supply side, agriculture and allied activities contracted, while manufacturing activity weakened sharply.
The Monetary Policy Committee (MPC) has changed its stance to ‘accommodative’ from ‘neutral’. This is a clear indication that the central bank is concerned about growth and is prepared to use interest rates and liquidity to boost demand. So, bond yields may have further room to drop as the markets would expect a further rate cut of 25 bps in August.
Suvodeep Rakshit, senior economist, Kotak Institutional Equities, says RBI’s change in stance to ‘accommodative’ was a bit of a surprise. “Debt markets will take this as a significant positive move though most of the rate cut cycle is probably over. The tone of the RBI policy was dovish and highlights the concerns on growth. We maintain our call for another 25 bps rate cut in August factoring in the benign inflation trajectory and the growing concerns on growth,” he says.
Depositors may be hit as fixed deposit (FD) rates are likely to decline as falling interest rates will prevent investors of fixed coupon payments from earning the same rate of returns after maturity. Individuals should lock-in at current fixed deposit rates before banks start reducing the rates.
While bank deposits are preferred financial assets of any household, a study by RBI says the correlation between interest rates and deposit mobilisation seems rather weak and income is the most important determinant of deposits. Also, the widening gap between credit and deposit growth is triggering concerns about liquidity gap in the system. The RBI study says that accelerating the rate of growth in the economy and disposable income is crucial to higher deposit mobilisation in the banking system.
Bank deposit grew 10% during 2018-19 and credit offtake grew at 13.2% during the year. Time deposits account for around 88% of aggregate deposits and deposits mobilised by public sector banks is the prime mover of aggregate deposits.
A report by CARE Ratings says bank deposit growth will benefit partly from the present crisis in non-banking financial companies where debt funds have been impacted and households are likely to move back to bank deposits. However, lowering of rates will make deposits less attractive for savers.
Given the fact that company deposits fetch 50 to 150 basis points more returns than than bank deposits, many individuals prefer investing in company deposits. Investors must exercise utmost caution and take an informed decision because, unlike bank deposits, a company can default on payment of interest and principal. Bank deposits provide security of up to an investment of `1 lakh, which is not the case with corporate fixed deposits.
For instance, recently liquidity-starved Dewan Housing Finance Ltd (DHFL) has stopped premature withdrawals of its deposits. It has also stopped accepting fresh public deposits and renewals of existing deposits. The company, however, said that it will continue to honour all premature deposit withdrawal requests in any medical or financial emergency. The company’s fixed deposit liability is `12,000 crore, which has also been downgraded by the rating agencies.
As company fixed deposits are unsecured loans, repayment of principal and interest are not guaranteed, and in case of any default or delay, investors have little recourse. So, since the risk involved in company deposits are higher than bank FDs, the interest rates are generally higher. If the credit rating of the company is AAA, then it means it is a safe and secure investment. If the rating is lower, there could be risks involved. Even after investing, investors must check the ratings of the company regularly. One must analyse the financial statements, performance of the company and its management to take an informed decision. Analysts say investors must completely ignore the unrated companies and deposit schemes of little-known manufacturing companies.