Options when inflation is eating into your fixed deposits

Invest for the short term as returns will increase once the pandemic is over

Retail inflation accelerated to a six-month high of 6.3 per cent in May, making actual returns negative for bank depositors. Fixed deposit rates of banks are around 5 per cent. State Bank of India – the country’s largest lender – offers 5 per cent for one year to less than two-year deposits and 5.1 per cent for two years to less than three years.

Inflation is not likely to come down substantially soon. Earlier this month, the Reserve Bank of India (RBI) had projected 5.1 per cent Consumer Price Index (CPI) inflation for the current financial year. However, the projection could be revised upward as there are upside risks to inflation due to the hardening of crude oil prices and domestic supply constraints. In the previous financial year, average inflation was 6.22 per cent.

Neither are interest rates of fixed deposits going to increase anytime soon, at least not in the current financial year. The central bank has clearly said it would continue with its ultra-loose stance of the monetary policy by providing sufficient liquidity in the banking system and keeping interest rates low until economic growth revives on a sustainable basis.

In such a scenario, what are the options for retail investors? Although limited, there are few options with similar risk profiles which offer better returns than bank fixed deposits.

RBI bond: Such bonds are issued by the Government of India, hence much less risky than even bank fixed deposits. The interest of the bond, which is linked to the national savings certificate, is altered half-yearly. The interest rate between January 1 and June 30 is fixed at 7.15 per cent. Half-yearly interest is payable on January 1 / July 1.

“If you can lock in money and are comfortable from a cash perspective, you can go for an RBI bond, which has a floating interest rate. The return will always be higher than the bank fixed deposit rate. At least you should be able to remain afloat as far as inflation is concerned, on a pre-tax basis,” says Surya Bhatia, a New Delhi-based financial investment advisor.

The only drawback of this scheme is that money is locked in for seven years and five years for senior citizens.

Post office Senior Citizen Savings Scheme (SCSS): This is an option for citizens above 60 years. At present, the interest rate offered is 7.4 per cent, paid quarterly. If an account holder does not claim the interest payable every quarter, such interest shall not earn additional interest. The maximum amount one individual can invest in this scheme is Rs 15 lakh. The account can be closed after five years from opening by submitting a prescribed application form with a passbook at the concerned Post Office.

Bonds and NCDs: This is a scheme for someone who already has a regular income. These bonds and non-convertible debentures are available in the secondary market. Depending on the risk one is willing to take, the returns vary between 6.5-7 per cent to 9.5 -10 per cent. “An AA rated bond – for example, a Bank of Baroda perpetual bond – you will get at 7.5 per cent in the secondary market. The only thing is, it is available in the secondary market in the Rs 10 lakh lot, that is, one has to invest at least Rs 10 lakh in these bonds. So, to that extent, there is that constraint,” said Suresh Sadagopan, a certified financial planner.

While there was an issue with the perpetual bonds of Yes Bank – when the SBI and other lender were helping revive the bank – the Additional Tier-I bonds were written down. Apart from institutional investors, retail participation was also there in those bonds that lost their money. Analysts see such an event as an exception. “Whatever has happened in Yes Bank probably is not going to happen in the case of Bank of Baroda,” says Sadagopan.

Debt mutual funds: The risk profile of the debt mutual fund products is like fixed deposits. “For example, Bharat Bond fund has the potential to give 6.5-6.7 per cent. It is a debt mutual fund-long duration product - so the tax treatment beyond three years will be favourable. It has liquidity, which is at any point you can get out of that. The advantage is it is very secure because underlying investments are in AAA-rated PSU bonds. So, if you do not want income regularly, then this is an option – better than FDs, with minimal risk,” Sadagopan said.

Another option is the government Gilt Funds. These are the schemes that invest in central and state government securities issued by the Reserve Bank of India. While returns were not very attractive last year, some funds with a moderate risk profile have given returns over 9 per cent in the three-year period. However, gilt funds can be volatile at times, so investors should take a medium to long term view. PSU bond index fund is also available for investment which is a high-quality bond.

“If you hold it for five years, you are assured of getting a return of 6 per cent. And because it is a mutual fund, you can benefit from long term capital gains. The only challenge is you do not have an income given over there. In that case, you can start a systematic withdrawal plan,” Bhatia said.

One suggestion that the financial planner offers is that, currently, one should invest in the short term because returns will be better after a year or so. “What we see today is not likely to go on forever. These are very unusual times,” Sadagopan said, indicating the current benign interest regime. “At some point in time, we will again start getting a higher return from fixed deposits. If real returns are not there, then banks will not be able to collect deposits. Either inflation has to come down, or the rate of return has to go up. One should start getting a real return on their fixed deposits,” he said.

(The writer is a Mumbai-based journalist)