Mumbai: Shyma Varghese, 23, got her first salary and was planning to invest in a bank fixed deposit. However, the call centre employee has decided otherwise now. “With the inflation peaking to a seven-year high of 8.75%, a return of 8.50% on one-year fixed deposit does not attract me. The return on bank deposit has become negative. I am now looking for the next best investment option,” said Varghese.
Inflation is at 8.75%, but banks generally offer 8.5% for a one-year fixed deposit and interest rate earned on bank deposits are subject to tax. A person who pays 30% tax ends up earning 5.95% on the deposit. Here, the real interest earned turns out to be a negative 2.8%.
The rising inflation has affected the common man most as on the one hand his cost of living is increasing while the return of investments is falling. To contain inflation, the Reserve Bank of India (RBI) on 11 June hiked the repo rate (the rate at which banks borrow money from the central bank) by 25 basis points, or a quarter of a percentage point, to 8%.
The hike has now forced bankers to consider raising lending rates. However, they seem to be in no hurry to hike the deposit rates.
Prakash Mallya, chairman and managing director of Vijaya Bank, said: “People will never part ways with fixed deposits because of the certainty factor. A fixed deposit is a liquid investment. You can take your money anytime you want from the bank, there is no lock-in period as it is in mutual funds. People have confidence in banking system, equity market can never give you that kind of confidence.”
Banks cannot raise rates to counter inflation-related loss to the customers, he said. “We are also concerned about the situation but we cannot raise our deposit rates because our margins will be under pressure. As far as Vijaya Bank is concerned, our deposit base has gone up since March, we don’t see any problem here.”
“When inflation was at 4%, banks were offering 8% interest on deposits, said M.V. Nair, chairman and managing director, Union Bank of India. “Negative return on bank deposit on account of the rising inflation is also a passing phenomenon. The measures taken by the government and the central bank to tame inflation will reflect in the next two to three months. No individual will close their deposit account overnight because returns have turned negative. People like steadiness.”
Nilesh Shah, chief investment officer of ICICI Prudential Asset Management Co. Ltd, said it will be dangerous if investors stop saving. “High inflation should not dissuade investors from the habit of saving. Banking system cannot be ignored even at a time when inflation rate is high.”
“Stock market has been down for the last six months. This is a buying opportunity and investors should build up their portfolio in a slow and steady manner. Equities provide best protection, it is the best hedge against inflation. Mutual funds are attractive than bank deposits as the overhead costs are less than fixed deposits,” added Shah.
High inflation should not dissuade investors from the habit of saving.Nilesh ShahICICI PrudentialState Bank of India, the largest bank in the country, on 1 June increased interest rates by 35-50 basis points on deposits for two years to 10 years. But it decided to keep lending rates unchanged on 13 June.
In the past three years, interest rates on home loans have increased by 3%. At present, Housing Development Finance Corp. Ltd (HDFC) offers fixed rate home loans at 13.75% and charges 10.25% for floating rates loans. ICICI Bank Ltd’s home loans rates is linked to the ICICI Bank floating reference rate (FRR)/prime lending rate (PLR). Currently, the bank’s FRR stands at 12.75% and PLR at 14.75%.
Any further hike in lending rates could hit household budgets hard. If you have taken a Rs20 lakh home loan at a floating rate of 10.25% for 20 years, your equated monthly instalment (EMI) would be Rs19,933. A 50 basis points hike in the rate, to 10.75%, for the same loan will increase the EMI by Rs672 to Rs20,305. A 50 basis points hike in the rate for a fixed rate loan, to 14.25%, for the same amount and tenure will increase the EMI to Rs25,235 from Rs24,509, an increase of Rs726.
“Lending rates are bound to inch upward. However, the quantum is not yet decided. We will take a decision by the end of this month, as the coming weeks’ inflation numbers will factor in the recent fuel price hike. The market also awaits the banking regulator’s response to the high inflation numbers expected next week,” said a senior HDFC official who refused to be named.
“As a bank, we have not decided on a rate hike. Even if banks raise their interest rates by 50 basis points, we have seen, generally the EMI for a loan goes up by not more than Rs100 for a Rs4 lakh loan of three-year tenure. As such, the rate hikes will not have much impact on the auto loan takers. However, the sentiment of the auto loan market may be down,” said N.R. Narayanan, group business head, vehicle loans, at ICICI Bank.
“Interest rates across loan products are expected to harden in the range of 50-100 basis points. With the delinquency rate in retail assets increasing, select banks are looking at scaling down some portfolio like home loan and auto loan. Personal loan rates are anyways high considering they always have seen higher delinquency levels,” said a banking analyst from a foreign brokerage house.
Delinquencies across all retail asset categories have gone up and are likely to further increase in 2008-09, said the rating agency Crisil Study. Housing loans constitute over half of the total retail loans in India. Gross non-performing assets (NPAs) in home loans increased to 2.2% in March 2007 from 1.8% in 2005, and these are expected to increase to 2.7% in financial year 2008-09, said the study.
Car and commercial vehicle asset segments comprise one-third of total retail loans. The rating agency estimates that gross NPAs in these segments have increased to 2.3% and 4% as of end March 2007, from 0.9% and 3.2% respectively in 2005. In 2008-09, these numbers are seen at 3% for car loans and 5.5% for commercial vehicles.