Inflation and Fixed Deposits: Protecting Your Savings Against Rising Prices
In recent years, the inflation rate in India has gotten relatively high, resulting in the Reserve Bank of India (RBI) hiking the repo rate by 250 basis points since May 2022. This has caused several banks and NBFCs to increase their interest rates on fixed deposits significantly.
However, its effects do not end there as inflation has also influenced the returns generated by FDs, regardless of the type chosen. There could be a possibility wherein the instrument may not be able to beat it if the real returns continue being negative. Learn more about inflation and how to go about parking your funds in an FD during such situations.
What Is Inflation and How Does It Impacts FDs
Inflation is the overall increase in prices for goods and services over time in an economy. The Consumer Price Index (CPI) records the costs of a selection of products and services used by households and is used to measure it.
Effect on FD Interest Rates
The value of interest income from fixed deposits is also impacted by inflation, lowering the purchasing power. This is because the fixed deposit interest rates offered by banks and other financial institutions may be lower than inflation rates. As a result, the deposit's real value will gradually decline.
To combat inflation, the RBI tends to adjust the repo rate, which is the interest rate charged by the central bank when commercial banks borrow funds from it. Due to this, commercial banks find it more expensive to borrow money when the repo rate is hiked. This causes banks to raise the interest rates of both lending and deposits, establishing a link between inflation and loan/deposit interest rates.
Effect on investment returns
When estimating returns over time, it is necessary to consider the influence of inflation on them. Bank FD rates are typically known to fall short of outpacing inflation. In addition, FD returns may potentially be lower than the rate of inflation when taxes are subtracted from the interest income. This is especially applicable for long-term FDs.
Since FD rates are pre-determined and remain the same throughout the selected tenor, it could be ideal to opt for short-term FDs and make use of the constantly shifting interest rates. Furthermore, if you have chosen a short-term FD tenor and belong within the lower tax slab, then you may be the least impacted by inflation.
Impact of Inflation on FD Interest Rates
● FD tenor: Inflation’s impact on FD interest rates could differ based on the deposit tenor. While long-term deposits could offer some of the highest FD interest rates, they could also be quite susceptible to inflation.
● Interest rates by banks/NBFCs: The interest rates offered by various financial institutions could affect inflation’s impact on FD rates, as high ones could provide good protection against it. However, they may not remain attractive for too long.
Ways to Maximise Returns on Your FDs
You can make use of these useful tips to help maximise your earnings from your FD deposit during times of inflation:
● Avoid premature withdrawals
If you withdraw funds from your FD either prematurely or partially, you can risk being charged a penalty or getting lower returns. This can severely impact your overall returns, especially if it has a long-term tenor.
● Consider cumulative FDs
By choosing cumulative FDs, you will not only get comparatively higher interest rates, but your interest amount will be added to the principal and can gain further interest. This can lead to higher returns in the long run.
● Tax saving FDs
This is a special type of FD scheme wherein you can save on taxes under Section 80C of the Income Tax Act, 1961. This features a lock-in period of 5 years and can be applicable for monthly or quarterly payouts. Another way to save on taxes is by filing Forms 15G and 15H, if you meet the eligibility criteria.
● Auto-renewal
By auto-renewing your FD account, you can continue to earn interest on your lump sum deposited and improve your returns over the years.
● Compare fixed deposit interest rates
As an investor, comparing the varied interest rates offered by various banks and financial institutions before booking an FD is ideal. It is also recommended to calculate the returns that you can anticipate from your deposit, after considering the rate of inflation.
Furthermore, you can calculate your interest earnings with the help of handy FD calculators available online.
With this information, you may now have a better idea about how to navigate through inflation and find the best ways to increase your interest earnings via FDs. These are considered to be one of the safest forms of investing during times of uncertainty, so maximising your returns through them can prove to be quite beneficial.
Disclaimer: This content is part of a marketing initiative. No TNIE Group journalists were involved in the creation of this content.