RBI rate cut: Lock into prevailing FD rates before they decline further

Debt-oriented fund-of-funds, like income-plus-arbitrage funds and arbitrage funds are good options for debt fund investors

The Reserve Bank of India (RBI) on Thursday lowered the repo rate by 25 basis points to 5.25 per cent, taking the total reduction in 2025 to 125 basis points. Now that the regulator has ushered in a relatively low-rate phase, fixed-income investors should avoid knee-jerk reactions and respond in a well-thought-out manner to this regime.

 

Will rates be cut further? 

Fund managers broadly agree that the RBI is nearing the end of the current rate-cut cycle. “The scope for aggressive easing is limited. Inflation is near record lows now. But we believe that the RBI may focus on one-year forward inflation, which is expected to rise modestly due to base effects and food price normalisation, though GST cuts should keep it contained,” says Devang Shah, head - fixed income, Axis Mutual Fund. 

Sneha Pandey, fund manager - fixed income, Quantum Asset Management Company (Quantum AMC), also expects 5.25 per cent to be the terminal rate in this rate-cut cycle in the base-case scenario.

 

Compare FD rates across banks 

Fixed deposit rates are poised to soften. “The repo rate cut and stronger liquidity in the banking system should lead to banks cutting their FD rates further,” says Santosh Agarwal, chief executive officer, Paisabazaar. She advises investors planning fresh deposits to secure prevailing rates before they decline. 

Compare rates across banks. “Some may offer a higher rate for a specific time bucket because they need liquidity for that period,” says Arnav Pandya, founder, Moneyeduschool. Agarwal points out that small finance banks (SFBs) and a few smaller private sector banks continue to offer higher yields. Pandya suggests that conservative investors take limited exposure to SFBs. 

 

Small savings instruments 

Public Provident Fund (PPF, 7.1 per cent), Sukanya Samriddhi Yojana (SSY, 8.2 per cent) and Senior Citizen Savings Scheme (SCSS, 8.2 per cent) stand out as favourable small savings options. “PPF and SSY are especially attractive because the zero tax results in a high net return,” says Pandya. 

However, investors need to account for their limited liquidity. They are better suited for long-term investments. Moreover, SSY is available only for a girl child below the age of 10, while SCSS is restricted to those aged 60 or above.

 

Impact on debt MFs 

Mid- and short-duration funds align well with prevailing conditions. “With limited scope for further rate cuts and the RBI’s focus on maintaining easy liquidity conditions through open market operations and foreign exchange swaps, these categories can capture incremental gains without exposing investors to high volatility,” says Shah. 

Pandey recommends dynamic bond funds. “Here, fund managers manage interest rate risk actively,” she says.

Deepesh Raghaw, a Sebi-registered investment adviser, recommends liquid and money market funds to his clients because both credit and interest rate risk are largely contained in them. He also sees merit in arbitrage funds owing to their equity-like tax treatment.

 

Long-duration funds are less compelling at this stage. “The rate-cut cycle is over or almost over. Long-duration funds are attractive before or early in a rate-cut cycle,” says Joydeep Sen, independent debt expert and author. Sen advises aligning investment horizons with the maturity profile of funds: liquid funds for a one-month horizon, corporate or short-duration funds for three-five years, and so on. “Debt-oriented fund-of-funds, like income-plus-arbitrage funds, offer low volatility combined with tax efficiency,” says Sen. 

According to Raghaw, those concerned about muted debt mutual fund returns (they are taxed at slab rate) may consider hybrid strategies such as equity savings.

 

Investors, meanwhile, must guard against taking excessive credit risk through lower-rated bonds or credit-risk funds. They should also avoid duration risk via long-term debt funds if their time horizon is short or moderate. Past performance of such instruments should not be the basis for future allocations.