In the current volatile market, investors seek stable investment options with assured returns. An effective strategy to steadily increase savings is to invest in low-risk avenues providing attractive returns.
A prime example is a fixed deposit, which ensures consistent returns over the investment period without impacting the initial capital. Nevertheless, the interest rate on fixed deposits varies across different financial institutions.
Do Fixed Deposit Rates Change Frequently?
If you have invested in a fixed deposit as part of your financial strategy, you may be aware that the interest rates on such deposits are not fixed. Banks and financial institutions periodically adjust their fixed deposit interest rates.
These rates can either increase or decrease, due to various factors. Nevertheless, the interest rate applicable at the time of deposit will remain consistent throughout the investment duration.
For example, suppose you deposit ₹2 Lakh in your fixed deposit account on April 1, 2023, for a 2-year tenure. Assuming the prevailing fixed deposit interest rate on that date is 6.25% per annum.
Suppose, the bank reduces the fixed deposit rates to 6.10% per annum on July 1, 2023, in the subsequent quarter. In this scenario, your fixed deposit will retain the initial interest rate of 6.25% per annum, and the revised rates will have no effect on your deposit’s interest earnings.
What are the reasons for revising FD interest rates?
FD interest rates are subject to revision due to several factors. Financial institutions and banks consider these key parameters when determining changes in FD interest rates. Here are the factors that influence the revision of FD rates.
The Revision of Repo Rates
The repo rate, which represents the interest rate at which the Reserve Bank of India lends money to commercial banks in case of fund shortages, undergoes periodic assessments and occasional revisions by the RBI. These revisions are influenced by various factors.
For example, during periods of inflationary pressure, the RBI may raise the repo rate to restrict borrowings from the central bank. This action reduces the money supply in the economy, helping to control inflation.
Conversely, when the government aims to stimulate growth by increasing the money supply, the repo rate is lowered. An increase in repo rates leads to a corresponding rise in FD interest rates, providing benefits to depositors. Similarly, when repo rates are decreased, FD rates are also lowered.
Liquidity of the Institution
· Increase in rates: In situations where financial institutions experience poor liquidity, they may depend on retail fixed deposits (FDs) to fulfill their cash flow needs. During such periods, these institutions may increase FD rates to attract more deposits.
· Stable or no increase in interest rates: When there is sufficient liquidity, the demand for retail FDs may not be as critical. As a result, FD interest rates may not rise significantly or may not increase at all.
Influence of Credit Demand
The overall demand for credit plays a role in determining FD interest rates. When there is a higher demand for credit, it typically results in an increase in FD rates. However, when the demand for credit decreases, financial institutions have a tendency to decrease the interest rates on fixed deposits.
Steps to Take in the Case of FD Interest Rate Changes
Fixed deposit interest rates when hiked take place across all tenures. However, long-term fixed deposits tend to experience a greater rate hike compared to short-term ones. Given the inflationary trends, it is advisable to open a short-term fixed deposit account. Once inflation stabilizes, long-term fixed deposits can provide greater benefits.
Another strategy is to divide a large deposit into smaller portions with varying maturity dates. This approach allows for periodic liquidity while capitalizing on interest rate volatility. By reinvesting in longer-term deposits, investors can achieve better returns.
During periods of high volatility, it is recommended to opt for short-term fixed deposits, while high-interest rate periods are ideal for longer-term fixed deposits. Investing a substantial amount in long-term debt instruments when inflation is high is not advisable.
Conclusion
Fixed deposit interest rates are subject to periodic revisions based on various factors. These include changes in repo rates, the liquidity of financial institutions, and the overall demand for credit. It is important for investors to stay informed about these rate fluctuations and adjust their financial plans accordingly.
Short-term fixed deposits can be favorable during periods of volatility, while long-term deposits may offer better returns when inflation is stable. Utilizing strategies such as laddering deposits and using an FD return calculator can help optimize the benefits of fixed deposit investments.
