1. Introduction
A fixed deposit [FD] is meant for those investors who want to deposit a lump sum of money for a fixed period; say for a minimum period of 15 days to five years and above, thereby earning a higher rate of interest in return. Investor gets a lump sum (principal + interest) at the maturity of the deposit.
Bank fixed deposits are one of the most common savings scheme open to an average investor. Fixed deposits also give a higher rate of interest than a savings bank account. The facilities vary from bank to bank. Some of the facilities offered by banks are overdraft (loan) facility on the amount deposited, premature withdrawal before maturity period (which involves a loss of interest) etc. Bank deposits are fairly safer because banks are subject to control of the Reserve Bank of India.
With investment avenues increasing by the day it is quite easy to forget that until the reforms era kicked off in 1991; Indians had very limited means of investing their savings. While it is true that we have not yet seen any development on the lines of the more developed economies there are a number of instruments today that were unheard of amidst the lay investors just a short decade ago. On the one hand investors are still struggling to come to terms with the complex nature of some securities and on the other intermediaries are trying to raise the investors’ awareness. Stock favorites such as FDs are meanwhile enjoying a renewed burst of popularity.
It is observed that in the past few years due to soaring stock markets and decrease in the interest rates for fixed deposits, fixed deposits were stopped to be the favorable deposits and very few people wanted to invest in the fixed deposit. Also, the government’s saving schemes, especially the post office saving schemes, had an edge over the FDs.
But the recent crashes in the stock markets and rising interest rates, FD have become the flavour of the month.
However, the recent changes have again brought investments in FDs into the limelight. The contributing factors include the decision to give tax breaks in terms of coverage under Section 80C of the Income Tax Act. Another important factor has been the gradual increase in the interest rates on FDs. The increase in the interest rates is primarily due to the soaring inflation of 12%. The regulatory actions to curb inflation have done something good for the fixed depositors at least in short term. It was the understanding on government and Reserve Bank Of India’s (RBI) part that growth needs to be sacrificed, demand in economy has to be brought down and credit offtake from banking sector has to be brought down substantially from 25-26 per cent credit offtake growth of last year in order to save this economy, which is looking fragile due to rising inflation. Battling the war on inflation has forced RBI to squeeze liquidity from banking system and make credit availability tough for the market. Banks have responded to the RBI’s action positively and now these steps have seemingly pushed India into the high interest regime. All the banks in the country are announcing the interest rate hike and bringing the stiff competition among the banks as to who will eat the bigger pie of the fixed deposit in country.
The slump in the capital markets and the large amounts of losses by investors in IPOs are a couple of factors for this hunt for security by investors, even at the cost of lower returns. The central bank, RBI, and the market regulator, SEBI, have been attempting to rein in unscrupulous operators from cashing in on this rush for FDs. In fact, between 1994 and 1996 a few states like Tamil Nadu saw a literal explosion of FD offers with promises of impossible returns like 36 per cent to even 50 per cent per annum in some cases. A number of gullible investors saw their savings go up in smoke at the hands of such corporate entities. It is only recently that credit rating has been made mandatory for FD raising exercises, as were prudential norms.
However, the bitter lesson resulted in investors ignoring almost all other factors barring security while investing their savings. Thus, the past two years have seen a huge growth in bank deposits and in the FD levels of the better segment of India Inc.
In India there are a number of avenues for such investors, with the most popular forms being:
· Fixed deposits with banks and post offices.
· Fixed deposits with companies.
· Public sector bonds.
· Income-oriented units and growth oriented units.
· Non-convertible debentures of private sector.
· Convertible debentures*
· National Savings Certificates.
· Provident Fund contributions.
· Kishan Vikas Patra
Provident funds and public provident funds are also excellent areas of investment and offer both initial and a continuing tax advantage. There are added benefits such as the existence of a facility for partial withdrawals, attractive rates of returns and immunity from attachment of a court decree. If someone is on the hunt for a tax-sheltered current income then he should give preference to income-oriented units and public sector bonds as rates of return are more attractive than other fixed income avenues with similar tax benefits. Convertible debentures of reputed, profit making companies are also worth picking up. Such securities are traded lower than the company’s underlying equity. The company pays interest until conversion after which the investor gets dividend income. If ones taxable income is less than Rs.1, 50,000 and he has exhausted the limits for various tax-sheltered investments, non-convertible debentures, and corporate fixed deposit schemes would then be his best bet.
2. Preference for FD-Something for Everyone
Although the financial markets have become more mature and now offer a much greater variety of investment avenues. Despites these, FDs have not lost their relevance and they are considered a vital investment instrument by a broader investor base:
Risk Taking Investors: The shaky stock markets have renewed investors’ interest in fixed deposits. These instruments lend stability to an investment due to the assured returns that they offer. As a result, they form an integral part of the portfolios of even the most high risk investors.
Small Investors: The minimum sum that can be invested for some specific schemes is as low as Rs. 100, making it ideal for the small investors. The high inflation rates and the resultant hawkish monetary policy have led to higher FD rates, further enhancing their ‘attraction’ quotient. Most banks offer automatic renewal of the deposits on the maturity which ensures that investors don’t lose a single day of earning interest.
Large Investors: Investors who wish to park large funds in some short term avenue until they decide how it should be allocated among various asset classes find FDs ideal. Thus, they enjoy better interest rates, their capital remains intact and moreover, there is greater flexibility in terms of the maturity periods.
Retired Investors: Senior citizens enjoy higher interest returns on FDs than others. Normally, the rate of interest on FD for senior citizen is 0.50% higher than the normal rates. FD also offers a regular stream of income through the options of receiving interest on a quarterly basis, as per requirements. Moreover, with no or less taxable income, FDs and be a tax-efficient method of investing.
Tax Savers: Certain FDs are entitled to income tax exemption up to a limit of Rs. One lakh, under section 80C of Income Tax Act. These deposits should be locked in for a period of 5 years to qualify for the benefit and no withdrawal before maturity and loan is permissible.
3. New Innovations-Spicing up the FDs
Though the comfort level of investors with bank deposits is high, these products used to suffer from inherent deficiencies like limited liquidity, unattractive interest rates, tax inefficiency, etc. Banks have introduced a few innovations to counter these and spice up their offering to attract and retain their customers. These are given as below:
1. Floating Rate Deposits: Often, one is confused about the direction in which interest rates will move. There is also the concern that interest rates may rise once you have committed funds to a fixed deposit. To mitigate this dilemma, banks now offer floating rate deposits where the rates rise or fall depending on the prevailing trend and are reset at periodical intervals, linked to a benchmarks. Such rates are beneficial when interest rates are rising but detrimental when the rates are falling.
2. Sweep in Facility: This is by far the most relevant and useful innovation that negates human inertia. It allows one to automatically transfer surplus funds, beyond a threshold which are lazing in ones savings bank account into FDs.
3. Tax Benefits: Almost all banks now offer the tax saver deposit which qualifies as an eligible investment up to rupees one lakh (consolidated with other tax saving instruments), under section 80C of the income tax act, for income tax deduction, with a lock in of five years.
4. Auto Renewal: This facility preempts the need to remember the maturity dates of various deposits. The deposit is automatically renewed on maturity as per the depositor’s instructions. The risk of losing further interest on a matured deposit is thus removed.
5. Insurance Cover: Most of the banks in India are now offering the insurance cover to its recurring deposits as well as its fixed deposit customers.
6. Consolidation: Now the banks have started offering passbook with the entries of all the deposits so that the hassle of handling numerous receipts is avoided.
7. Other Benefits: Some other benefits offered by the banks to its high valued customers include waiver of demand draft commission, outstation cheque commission, free ATM cards and credit cards, etc.
4. Checklist for the FD investors
With the equity markets hovering around the precariously high 21,000 levels, investors have been left wondering where they should invest in the current scenario. In the meanwhile another anticipated event finally occurred; some financial institutions accepting FDs hiked the rates on their offerings. This makes FDs attractive propositions not only from the short-term investment perspective but also to park funds until better opportunities are thrown up by the equity markets. In the following lines a few points which FD investors must consider at the time of investment have been given:
1. Safety: FDs have conventionally been the premier choice for investors with a low risk appetite; assured returns is the key factor which attracts investors towards deposits. Stick to FDs of the highest credit rating i.e. those with a “AAA” rating even if their rates seem modest vis-à-vis those offered by company deposits. Company deposits are unsecured in nature and investing in them would imply taking on disproportionately higher risk. If as an investor someone is open to investing in instruments involving higher risk levels, market linked instruments like mutual funds may not be a bad deal.
2. Tenure: Short tenured FDs continue to be the best bet. With interest rates on the ascent, a further hike in rates offered by fixed deposits cannot be ruled out. Locking your investments in longer tenured instruments may lead to an opportunity loss. Even if a 3-Yr FD looks like a lucrative proposition as compared to one which runs over a year or so, pick the short tenured one. In a rising rate scenario, one could be more than compensated for the lower returns at present.
3. Liquidity: Find out how the FD fares on the pre-mature encashment front i.e. how easily can the investment is liquidated. Also enquire about the penalty clauses, e.g. is there a loss of interest and/or principal amount. Compare how various FDs rank on this parameter and pick the best deal; thereby try to minimise the impact of illiquidity which is typically associated with FDs.
4. Additional benefits: Fixed deposits from reputed entities offer additional benefits, e.g. they can be used as collateral against which loans can be raised. Select a fixed deposit scheme which scores favorably on such parameters.
5. Conclusion
Yes, now the bank deposits are back in action. The age-old hassle-free investment method now looks very attractive as the return from the bank’s fixed deposit is effectively comparable to stock market return. In short term when stock market sentiments are not so upbeat fixed deposit has brought some respite for the investors. At this juncture when interest rate in economy is hitting the roof, it is time for both the spendthrift and the people who are in habit of cutting down their expenditure to save for future, to rejoice. As is the basic rule in choosing any investment option, here too it is essential that the investor decides in advance the proportion of investing in stocks and bonds. Periodic evaluation is equally important and while necessary changes have to be made, investments must never be switched for negligible changes in interest rates.
References
Websites
1. http://www.thebharat.com/finance/fixeddeposits/index.html, accessed on 12th of September, 2008 at 2000 hrs.
2. http://www.webindia123.com/finance/bank/fix.htm , accessed on 12th of September, 2008 at 2010 hrs.
3. http://www.merinews.com/catfull.jsp?articleID=139299, , accessed on 12th of September, 2008 at 2015 hrs.
4. http://economictimes.indiatimes.com/Personal_Finance/Fixed_Deposits/articlelist/2146932.cms, accessed on 12th of September, 2008 at 2030 hrs.
5. http://economictimes.indiatimes.com/Personal_Finance/Fixed_Deposits/Fixed_deposit_draws_investors/articleshow/3259501.cms, accessed on 12th of September, 2008 at 2035 hrs.
6. http://www.personalfn.com/detail.asp?date=11/19/2004&story=1, , accessed on 12th of September, 2008 at 2015 hrs.
News Paper Article:
1. Raheja P (2008), Fixed Deposits-Making Room for Everyone, Times of India, September 11
2. Sreekant V (2008), Spicing Up the FD, Times of India, September 11
Book
1. Bezborah P & Singh R (2008), Indian Financial System, Kalyani Publishers
2. Khan M.Y.(2004), Indian Financial System, Tata Mc Grew Hill Publishing Company, 3rd Edition.
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