Interest rates in India were on a steady decline for the last few years and the demonetization of 500 and 1000 rupee notes has just accelerated the process. Many banks like ICICI Bank, HDFC Bank, Canara bank have announced a rate cut (ranging from 10 bps -0.10 % to 50 bps -0.50 % depending upon the tenure of the fixed deposit) with immediate effect, all other banks too will follow suit soon. Even AA+ rated companies like Mahindra and Mahindra Finance, Dewan Housing Finance, Shriram Transport Finance have cut their deposit rates.
This was long overdue; as India is one of the very few developing economies with such high interest rates and sooner or later they would have had to align with the global rates and lower interest rates will also stimulate economic growth. While all this is theoretically logical, fixed income investors especially retirees who are dependent on the interest for their regular expenses now face a practical problem – where to invest so as to get a reasonable amount of fixed income assuming low risk on principal? India does not have a social security system like the developed countries do which makes it all the more important to explore alternate low risk investment options .
- Company fixed deposits – Though they have higher interest rates varying from 50 bps to 200/300 bps higher than standard bank deposits, people are not comfortable putting in their money as the general perception is that it is risky as they are unsecured. True, they are riskier than bank fixed deposits, but AA+ rated plus deposits rate high on safety and can be considered. Moreover, there is no guarantee than banks cannot go bust. And DICGC – The deposit Insurance and credit guarantee corporation guarantees only up to 1 lakh bank deposit per client, so anything above that is unsecured.
- Senior Citizen’s Savings Scheme (SCSS) is one of the most attractive options for the retired. Up to 15 Lakhs per account above age 60, and the current interest rate is 8.6 % pa fully taxable for the financial year 2016-2017. The tenure is 5 years and the scheme carries the highest safety.
- Tax free Bonds – These too carry sovereign risk- highest safety. The coupon rate is usually lower than that of fixed deposits, but for those in the highest tax bracket, the effective returns is higher than the post -tax returns of the taxable fixed deposits. The main disadvantage is the high lock in period – 10/15/20 years. These bonds are trade able in the secondary market; but how soon it can be liquidated in case of emergency depends on the trading frequency and volume. Another disadvantage is that they offer only annual interest under the non -cumulative option hence may not suit those who are looking for regular income. There are very few new issues coming out in the market, but one can always buy the existing ones being traded at the ongoing bond prices.
- Debt schemes of mutual funds – These don’t guarantee a fixed return, but score over fixed deposits in terms of tax efficiency for those taxed at the highest slab. These are liquid, can be withdrawn anytime and have monthly, quarterly and half yearly dividend payout options too, but the amount of dividend paid is variable, not a regular fixed amount.
- Government of India 8 % taxable bonds – These bonds were not a favorite till recently, since long term fixed deposits paid more than this, and with the interest being taxable like FD interest, there was no clear advantage of investing in these. But now with the fixed deposit rates having reduced drastically, one could consider this. But only half yearly option is available in non-cumulative category which may not suit those wanting regular monthly income.
- Post office Monthly Income Option – This is an evergreen product suitable to senior citizens with low risk appetite. The interest is payable monthly and the current rate is 7.7 % pa , and one can invest up to 4.5 lakhs in single name and up to 9 lakhs jointly. The tenure is 6 years (premature withdrawal facility is available after one year with some deductions). This product has an attractive feature – a bonus of 5 % on the principal which is paid if the deposit is held till maturity, i.e 6 years. The disadvantage of this product is that it is fully taxable, making the returns almost comparable to fixed deposits, which is why it is the last one on the list.
Our economy is going through troubled and challenging times – low growth rate and the falling rupee has left very few investment options for us- the retail investors. In 2012,
Equity markets – were volatile and the future trend unclear
Real estate- Sluggish
Gold – Prices have barely moved much
Fixed Income – The interest rates are on a downtrend
For ages, bank fixed deposits have been popular among investors as a safe and hassle free investment haven. People are so comfortable placing their money in deposits that they often do not consider investing in debt schemes and other comparative products. This could be because of lack of awareness or because of the following features which seem to make fixed deposits attractive.
- Fixed deposits are safe – Banks in India are regulated by the Reserve Bank of India and in the event of a bank going bust, DICGC (Deposit Insurance Credit Guarantee Corporation) covers all fixed deposits to the tune of Rs 1 Lakh. This is applicable per depositor in a bank inclusive of principal and interest.
- Ease of operation – Fixed deposits is a simple product easy to start and can be closed prematurely at any time by the depositor.
- Fixed rate of return – While applying for a deposit, the investor knows the rate of return and the exact maturity value which he would get at the end of the invested period.
- Tax benefits – Some special fixed deposits in banks with a lock-in of 5 years are eligible for income tax rebate of up to Rs 1 Lakh under section 80 C.
Now, the drawbacks –
- Lower tax adjusted returns – The interest earned on fixed deposits is fully taxable as per the investor’s tax bracket, hence the post tax returns are low.
- Effect of Inflation – The prevailing high inflation rates in our country (8 % currently) and the low post tax returns ensure that the real rate of return is negligible, if not negative! This means that your money does not grow at all.
- The guaranteed fixed return means that the depositor doesn’t have a chance to earn higher returns than that promised. In the past, during a falling interest rate scenario govt. securities with lower risk have given double digit returns, and during rising interest rates in the economy floating rate debt funds have done exceedingly well. But those who were invested in fixed deposits during these times still got only the fixed interest rate.
- On premature closure of fixed deposits, most banks charge a penalty which the investor has to bear, apart from getting a lower interest rate applicable for the period for which the deposit stays with the bank. For Example – If I open a fixed deposit for Rs 1 Lakh @ 9.5 % pa for 3 years, and am forced to close the deposit after an year, not only would I have to bear the penal charges of say 1 % for pre-closure, the entire 1 lakh would earn only an interest of 8 % pa applicable to deposits of 1 year duration. In effect, I would have earned only a gross interest rate of 7 % pa.
In conclusion, a word of caution.
Co-operative banks, especially the unscheduled ones are best avoided though they offer rates of return which are as much as 2% pa higher than other banks. During the last year 2011, 9 co-operative banks have closed down. This figure was 19 in the year 2009. Getting the insurance money on bankruptcy is also not easy. The Reserve Bank of India first tries to revive the bank and in the event of liquidation, the insurance money is released only on completion of the liquidation process which means the investor could have to wait for a long time to get his money back.