Investors swap FDs for MFs in a quest for better returns

A section of traditional Indian investors may have gradually started moving away from their preferred savings instrument as bank deposit rates plummet to historic lows, and are looking at avenues for higher returns despite increased risks.

Experts said small savers who used to rely on bank fixed deposits for guaranteed ‘risk-free’ returns are now increasing their exposure to debt and equity mutual funds. The shift in preference was reflected in the numbers for May—while growth in bank deposit declined, inflows in mutual funds soared.

Since crossing the ₹150 trillion mark in March, bank deposits, which have been growing at 10-11% every month, fell to 9.7% as on 21 May, adding just ₹32,482 crore between 23 April and 21 May, against ₹1.2 trillion in the corresponding period of last year.

Mutual funds, on the other hand, saw record net inflows in May at ₹9,235.48 crore, the highest in 14 months. The buoyancy in the equity markets despite the covid-induced economic slowdown may have added to the optimism.

The Reserve Bank of India’s accommodative monetary policy has led to an abundance in liquidity, allowing banks to cut deposit rates, as the central bank has lowered the repo rate by 115 basis points since March 2020. While savers are bearing the brunt of the move, policymakers are hopeful that an increase in lending due to lower rates will boost economic growth.

For instance, India’s largest lender, State Bank of India, pays 5% interest on its 1-2-year fixed deposits, down from 5.9% in March 2020.

Increasingly, small savers have realized that with bank interest rates on a decline for the past few years, inflation-adjusted returns over the long term could only be achieved through investments in mutual funds, said N.S. Venkatesh, chief executive, Association of Mutual Funds in India (Amfi), the nodal agency for mutual funds in India.

“Depending on their life-stage goals and risk appetite, small savers do have a plethora of options within different mutual fund schemes, be it equity, debt or hybrid, to deploy their savings, unlike bank deposits,” he added.

While inflation remains within the RBI’s flexible target of 2-6%, savers will still earn little in terms of real returns on their deposits. Adjusted for inflation, real return on 1-2-year term deposits stood at 0.71%. Inflation measured by the consumer price index (CPI) was at 4.29% in April and SBI’s 1-2-year deposit rate is typically adjusted for inflation to arrive at the real rate.

“The lower growth rate (y-o-y) in deposits can be partly attributed to base effect and a fall in deposits rate of banks as the weighted average domestic term deposit rate of banks fell by 71 basis points between April 2020 and April 2021. Also, inflows in debt mutual funds and equity mutual funds may have led to the decline in bank deposit value,” Care Ratings said in a report on 5 June.

However, there may be some hope for depositors as senior bankers said that deposit rates are not likely to fall further. In fact, SBI chairman Dinesh Khara told analysts that deposit rates have already bottomed out. “It may not go down anymore,” he said on 21 May, acknowledging that in India, deposits are a major source of income for many retirees and are always a function of inflation.