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The interest rate in India has seen a gradual decline since the demonetisation. But the last nail in the coffer was the COVID-19 pandemic.

The Reserve Bank of India (RBI) had to cut rates to make funds more affordable to the banking system. Thus, the large banks receive low-cost funds and they did not have to pay high-interest rates to a retail depositor. Luckily in the case of India, it is not offering zero or no interest rate, unlike some countries.

For a senior citizen, this decline in interest rate comes as a big pinch just in case he or she wishes to save some moolah in a bank as a fixed deposit (FD) at this time of the pandemic. If the same investment was made a few days months before the announcement of various RBI cuts, one could have taken home around 6 (plus or minus) per cent interest rate based on the tenure.

While commercial banks like State Bank of India, Bank of Baroda, HDFC Bank, ICICI Bank among others are offering around 3-6 per cent interest on FDs.

There are small finance banks which are offering up to 9 per cent based on tenure and amount. The reason small finance banks are giving away higher interest rates compared to commercial banks has more to do with the fact that these banks look at financial inclusion by the provision of savings options to depositors and supply of credit to small business units, small farmers, micro and small industries, and other unorganised sector entities.

But today, FD is not a favourite among the working middle class. While they do open an FD once in a while, they also explore other options like mutual funds, SIP, gold, provident funds and others.

As a retail investor, one is aware that interest rates are dropping but does not know the factors that influence this drop. So, we listed a few instruments that can impact the interest rate in general:

More liquidity

Funds are also governed by the concept of demand and supply. If there is excess money or lag in credit offtake, then interest rates will fall. In this scenario, cash is like that product in a company that has not found a customer or has been sold at a low margin. Despite this, you have to pay the money to the supplier (which is the depositor in this case). So, if you are under a contract with a supplier you pay him or her fixed cost (read FD). If it is a new supplier, then offer him or her a low price looking at market conditions. In the case of saving account, the interest rates change but in the case of FDs, it is fixed.

If the credit offtake is good, then return on FD is good. In the present scenario, the credit offtake is not good and there is more fund in the system. Another instance is banks usually lend at 12 per cent or more to a customer and a depositor receives only 7-8 per cent (or less) return on FDs. Thus, the bank makes a margin in the money it lends.

Inflation

Inflation will also affect interest rate levels. The higher the inflation rate, the more interest rates are likely to rise. In the case of India, it is said that India imports inflation in the form of crude oil. So, economists usually say for India to go into zero interest rate it is a more like an unthinkable phenomenon.

Reserve Bank of India/ Government

As mentioned earlier, when RBI cuts rates, interest rates fall as well. Other initiatives like open market transactions, long-term repo operations, government-backed funding etc, allow more flow of cash in the system. Thus, the interest rates fall yet again.

As a depositor, such initiatives do hurt the interest rate, but such initiatives are needed to help the economy run smooth. So, borrowers can get funds to carry out economic activity.

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