Why it may make good sense to invest in bank deposits at the earliest

There is a change of flow of wind for bank depositors. For more than two years they have been seeing an increase in the deposit rates offered by banks. Now it looks like the good period is over and once again they will be facing rough weather. There are indications that there may not be any hike in bank deposit rates, and chances are there that it may come down.

Larger banks have started cutting rates on short term fixed deposits of up to three years driven by better systemic liquidity conditions and softer short-term money market rates. The weighted average domestic term deposit rate on fresh rupee term deposits fell 12 basis points to 6.36 per cent in April from 6.48 per cent in March 2023. Fresh deposit rates for public sector banks were lower by 14 basis points and for private banks by 5 basis points.

Repo rate is the cost of borrowing for banks for their temporary accommodation from the Reserve Bank of India (RBI). Though the repo rate is not directly linked to deposit or lending rates, it is an indication for banks to align with. It is a monetary tool with the RBI to control inflation.

On August 1, 2018, the repo rate was 6.50 per cent. From then and up to May 22, 2020, the RBI reduced the repo rate. It was last reduced to 4 per cent. Bank depositors were feeling the pinch as the banks were correspondingly reducing the deposit interest rate.

More liquidity coming into the system

When the inflation was going out of hand, the RBI started an upward revision of repo; from May 2, 2022 till February 8, 2023 there was an upward revision. During this period the repo has been increased by 250 basis points (repo of 6.50 per cent). On April 6, 2023, the Monetary Policy Committee decided to maintain the status quo. On June 8, 2023, once again it has been decided not to change the repo rate.

As annual inflation rate slowed sharply to 4.7 per cent in April 2023, the lowest since October of 2021, the RBI may not increase repo rate in the near future and hence the deposit interest also may not increase.

The RBI has announced withdrawal of Rs 2,000 notes as part of Clean Note Policy. Though the Rs 2,000 note will continue to be legal tender, the public has been advised to deposit the notes in banks before September 30, 2023.

As of March-end 2023, Rs 2,000 notes in circulation constituted Rs 3.62 lakh-crore, or 10.8 per cent of notes in circulation, vs Rs 6.73 lakh-crore at its peak in March 2018. Most Rs 2,000 notes are likely to be initially deposited with banks and are expected to improve the deposit base and, thus, system liquidity.

As per Care Ratings report, withdrawal of Rs 2,000 notes could see an infusion of Rs 1-1.8 lakh-crore of liquidity over the June-September period.

Banks and funds

When so much of liquidity is increased, the banks may not be in need of further funds and hence may be tempted to reduce the deposit interest rates as part of cost-cutting exercises.

While the rate at which the RBI issues loans to commercial banks when there is a shortage of funds is the repo rate, the reverse repo is the variable or fixed interest rate banks deposit with the RBI. The variable rate reverse repo (VRRR) is the subdivision of reverse repo. The VRRR auction is undertaken to reduce surplus liquidity in the system by withdrawing existing cash.

In the last four VRRR auctions, banks have deployed funds aggregating Rs 151,733 crore against a cumulative notified amount of Rs 4.50 lakh-crore and it is believed that the banks are preserving liquidity as advance tax payments will lead to outflows in mid-June.

From the above, it is clear that banks are not willing to deposit the surplus with RBI under variable reverse repo rate. Their idea should be to deploy the same for their normal lending activities. Hence banks will not look forward for funds from depositors and hence may not price the deposit interest rate attractively.

Go for deposits

Considering all the above, it may be better for fixed income investors to invest in bank deposits now. While investment should be based on the asset allocation plan as per the individual’s risk appetite and return expectation, investment in fixed deposits as per the asset allocation plan can be done now.

Do remember that each depositor in a bank is insured up to a maximum of Rs 5 lakh for both principal and interest amount.

(The writer is a retired banker. The views expressed here are his own, and do not constitute investment advice.)