The interest rates on fixed deposits have seen a sharp rise since May 2022 when the Reserve Bank of India (RBI) started increasing the repo rates to curb inflation. Due to frequent repo rate hikes, there has been an overall increase of 2.25% in interest rates since then. However, now there are signs indicating that the rate-hike momentum has started slowing.

While increased interest rates augur well for FD investors, it has presented them with a quandary — should they wait for the rates to rise further or book their long-term FDs now? We tell you about the likely direction the interest rate will take and the best way to manage your investment into fixed deposits (FDs).

Interest rates are close to peak which is still a few months away

The likelihood of a further hike in interest rates cannot be ruled out completely yet. So, if investors book or start a long-term FD now, they may regret it later if the rates go up. On the other hand, if they wait longer for the rates to peak — which might not happen — they risk losing out on the current high rate. So, the first thing investors need to understand is the current interest rate position and its likely movement to formulate the right strategy for their FD investment.

Many experts find the interest rate situation to be close to the peak of the current rate-hike cycle. The movement of the 10-year G-sec yield curve gives a good indication of the likely direction of the long-term interest rate. Motilal Oswal Private Wealth says in its report “Winds of Change”, published in January 2023, “Unlike the US, India does not face similar concerns on inflation, hence interest rates are likely to peak out soon domestically. The yield curve in India has flattened out with the 1-year to 10-year G-sec yields trading in a narrow band of 6.75-7.35%.”

However, a few smaller hikes in interest rates cannot be ruled out. “Global markets are hinging on the likelihood of a pause in interest rate hikes; however, neither inflation nor the employment data suggest the same. Although we might see lesser rate hikes, stability and hopes of reduction seem farfetched as of now,” says Prabhudas Lilladher brokerage house in its India strategy report of January 2023,

FD rates may see smaller hikes for a few more months

Though the policy rates are likely to be closer to their peak, the transmission of these hikes into FD rates will take some time. Lenders are quick to pass on the increased interest rate to their borrowers, but they raise their deposit rates with a lag. As experts agree that a major part of the interest hike in policy rate is done and most of it has already been delivered into the FD rates, the likely hikes in the coming months may not be very substantial.

If we take the State Bank of India (SBI)’s FD rates, the interest rate on fixed deposits with a tenure of 2-3 years has risen from 5.10% in January 2022 to 6.75% in December 2022. It is a rise of 1.65%, which is only 0.6% lower than the entire repo rate hike of 2.25% in 2022. This shows that we are very close to the peak rates and further hikes may be only nominal ones and they would be done gradually to reach as close to 2.25% transmission as possible.

The highest rate is only for select tenure options close to 3 years

While the banks have raised their FD rates, this transmission has not been reflected in their long-term FD rates. Most of them are offering the highest rate for FDs of 2-3 years.

Whether a higher rate will be given for a longer-term FD tenure, like 5 years or above, will depend on the stickiness of the high interest rate regime. If the high interest rate situation continues to remain like this for a longer period, the higher interest rates on small saving schemes of longer tenure will give good competition to bank FDs. That may compel the banks to raise their interest rates on longer term FDs as well.

WHAT SHOULD YOU DO WITH YOUR FDS?

1. Use partial surplus to book FD now: Waiting for the interest rate to peak is a risky move. As the rates have risen significantly, you can divide your investible fund into three parts. Invest the first part now; wait for 6 months to book an FD using the second part and use the year-end period to put the third part into an FD. Until you put the second and third parts of the fund into longer term FDs at higher rates, use them for short-term FDs of 6 months and 11 months, respectively.

2. Make an FD ladder of 3 years: As many banks are currently offering the highest rate around the tenure of 3 years, making an FD ladder with a 3-year maturity profile can deliver a better return. For this, again divide your investible surplus into three parts. Invest the first part for one year, the second for two years and the third part for three years. After a year, when the first FD matures, invest it for 3 years. After two years, when the second FD matures, invest that also for 3 years. After that, your FDs will mature every year and you can reinvest these for three years.

3. When to break your old FDs: If you have many FDs locked in at a very low rate for a long period, it may be a worthwhile exercise to break them despite the penalty and reinvest using the current higher interest rate. You also need to be cautious and not break all your FDs in one go. If you have only one big older FD, break that and follow the methods mentioned earlier to divide the investment.

However, you should consider breaking your FD only when it is not close to its maturity and there is substantial time left for the deposit. You can do a calculation with the lower interest rate and penalty on premature withdrawal to find out the net gain if you break and reinvest an FD at a higher rate now.

4. Be cautious with small finance banks: Small finance banks have started offering interest rates of up to 9%, which may look tempting to many investors. However, you need to be cautious while investing in these banks. As there is an insurance cover of Rs 5 lakh — including both principal and interest — start a deposit with a maturity amount that is fully covered under this insurance, while investing in these banks. If there is a bigger amount to invest, you can invest in different rights and capacities — investing in the names of spouse, parents or children, or in joint accounts and so on — to enjoy the Rs 5 lakh cover separately on each FD.