Will the rush for fixed deposits be short-lived?

Are you from the generation that first consumed news on All India Radio and once collected audio cassettes of your favourite music? If yes, there is also a high chance that over the last 5-7 years, you learned that fixed deposits (FDs) don’t beat inflation and destroy wealth, courtesy of personal finance commentary across various multimedia mediums. The subsequent generations believe the notion more firmly. This popular narrative has influenced many to ditch FDs altogether in favour of equity and other asset classes. Even then, FD continues to be among the favourite savings instruments. Data from the Reserve Bank of India (RBI) shows that about ₹10.27 trillion was locked in bank deposits in fiscal year 2023. To put this number in perspective, only about ₹1.8 trillion household savings went into mutual funds through systematic investment plans (SIPs) in the same year.

Due to RBI’s hawkish stance on retail inflation and the rising retail demand for credit, term deposit rates in India have risen to their highest in the past decade. Thus, there is a significant positive arbitrage between the nominal interest rates on FDs and retail inflation. Take the example of someone in the zero tax bracket who invests in a 400-day FD by SBI at a 7.10% per annum interest rate compared to 5% annual retail inflation, i.e., a post-tax inflation-adjusted return of 2.10% per annum. When was the last time we heard such gains from an FD?

The key interest rates are expected to start reducing in the next calendar year, and the banking sector will gradually follow suit. This makes it an excellent time for retail investors to lock in the FD rates for 3-5 years. But here comes another question: Are FDs only good for now? Will they again be a subpar product when the interest rates start going down? Perhaps, no. FDs will still be relevant (irrespective of interest rate cycles). Here are a few reasons:

Knitted in the culture: Traditionally, FDs have been the first and foremost investment instrument that Indian retail investors rely upon to park funds for their long-term plans. This has less to do with the interest rates and more with the generational confidence in the banking system. Just before the first outbreak of covid-19 (March 2020-end), the value of retail FDs in India was ₹41.3 trillion, i.e., approximately 28% of the FY20 real GDP. This was a time when the interest rates were significantly lower than today. The proportion shows that FDs form the core of retail investment culture in India, irrespective of the interest rate cycles. Going forward, even if the interest rates come down by a few basis points, the cultural web is hard to break.

Emergence of small finance banks (SFBs): Over the last 5-6 years, SFBs have been turning the game around on FDs. These banks offer 1-2% additional interest on term deposits to compete with their established peers, along with government-backed insurance of ₹5 lakh per account per person (like any other commercial bank). The additional interest rate goes a long way to bridge the gap between FD returns and the retail inflation rate. If the same investor mentioned earlier in the article invests in a 3–5-year FD of a small finance bank, she can expect close to 8.5% per annum interest rates and an even better post-tax inflation-adjusted gain of 3.5%.

Variety of use cases: Gone are the days when people would invest in FDs due to their lack of awareness about other investment options. Today, retail investors understand the utility of FDs at different stages of life. For example, a double-income couple could park their emergency funds or short-term needs in an FD. A senior citizen may look at FDs for low-risk debt investments. There are also sweep-in FDs where one can withdraw any amount, anytime, without foreclosure penalties. Such sweep-in FDs allow investors to optimize returns on additional cash lying in their savings accounts. With so many use cases, FDs will remain an important investment avenue.

Increased access: In the last five years, we have witnessed a significant boom in retail participation for direct equity and mutual funds. This was possible due to the digital innovation by new-age brokers, industry bodies and regulators. As an investment avenue becomes more accessible, it attracts mass participation. Today, we are witnessing a similar moment around FDs. Investors can book FDs of many small finance banks and A-rated NBFCs on the tap of their smartphone screens in less than five minutes. The ease of access eliminates the decision inertia and will propel more investors to look at FDs for their debt allocation.

Anshul Gupta is co-founder and CIO of Wint Wealth.