Don't keep cash idle in banks

Though the savings rate has been increased, it’s better to keep money invested in higher paying instruments.

The Reserve Bank of India (RBI) released discussion papers on savings rate deregulation last week. The apex bank has given time for public comments till May 20, and will decide the further course of action based on the feedback. In the Annual Credit Policy on May 3, the bank raised interest rates on savings bank deposits by 50 basis points (0.5 per cent) with immediate effect. So, savings bank account holders will now earn four per cent on their balance, instead of 3.5 percent earlier.

Even if the rise is being considered a precursor to deregulation, bankers aren’t sure when the latter will be implemented. Over time, RBI has deregulated all other rates, except savings bank rates across banks. The last time RBI mandated a change in the savings bank rate was 2003.
 

WEIGH YOUR OPTIONS

• High inflation will erode high returns from savings account 
• Savings account not for investment; at best for emergency funds
• Risk-averse investors could invest in fixed deposits; annual returns = over nine per cent (average)
• Rise in policy rates will push up fixed deposit rates further
• Debt funds are another option; annual returns = 6.50 per cent
• Those with higher risk taking ability could invest in debt-oriented hybrid funds

In the present high interest rate environment, deregulation or freeing rates would mean an interest higher than the four per cent on your savings deposit. Each bank would decide on its own rate of interest on savings accounts. For customers, it means being able to pick and choose the best rate available in the market. However, this could lead to unhealthy competition in the banking industry.

At the same time, interest rates will have to go well above inflation for real gains. Interest rates on savings deposits have mostly yielded negative returns, given that inflation has been soaring for almost a year. RBI expects inflation to fall back to six per cent only in March 2012. It means even the new rate of four per cent will yield negative returns.

Therefore, this option should not be used for investment. At best, you can keep you emergency funds in savings account.

For the risk-averse, investment could be done in other better return yielding avenues such as fixed deposits (FDs). At present, State Bank of India is offering 7.75 per cent on a one-year deposit and the highest 9.25 per cent on a 555-day deposit. ICICI Bank is giving 7.50 per cent for one year and 9.25 per cent for 590 days. Lakshmi Vilas Bank is offering 10 per cent for one to two years.

And, with RBI raising key policy rates, FD rates may go up further. For instance, IDBI Bank raised deposit rates by 50 basis points following the announcement.

Debt funds are another option for those with lower risk appetite. Debt funds such as liquid, liquid-plus or ultra short-term schemes with lower maturity are giving above average returns in the present high interest rate regime. And, this is only likely to benefit with RBI’s last rate increase.

At present, ultra short-term funds have returned 6.65 per cent in the last one year, according to mutual fund tracking agency, Value Research. They invest in debt and money-market instruments with a maturity ranging from 90 days to one year. Although they are riskier than liquid funds, investors get better and more tax-efficient returns. Funds have given 6.57 per cent.

Short-term funds investing in debt and money market instruments for one-two years have offered 5.48 per cent. Short-term debt funds will give better returns because of the constant churn that fund managers have to do. Income funds have returned 5.08 per cent.

Gilt funds have given over four per cent. These primarily invest in government securities issued as a part of the government’s borrowing programme. Best for those who seek safety and liquidity, the downside is that their prices fluctuate sharply due to higher sensitivity to interest rate movements.

Those with slightly higher risk-taking ability could invest in debt-oriented hybrid funds, which invest up to 65 per cent in debt instruments and remaining in equity. Thus, protecting the downside and giving the equity boost to your portfolio. Debt-oriented hybrid funds have returned 5.46 per cent in past year. These will also give tax benefit of 10 per cent without indexation and 20 per cent with indexation.