Invest in debt for a longer term, as interest rates may fall

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Published: Saturday, February 25, 2012, 10:18 [IST]
 
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Invest in debt for a longer term

If you have to make a difficult choice between placing a fixed deposit for one year or five years, it is recommended that you stick to five years.

This is simply because interest rates are likely to decline in the next one year and you would have locked-up money at higher interest rates for the longer term.

Why are interest rates likely to fall?

When inflation starts to gradually cool off, the Reserve Bank of India (RBI) tends to reduce the repo rates. Reduction in repo rates, reduces the cost of funds for banks, which in turn reduces loan rates as well as interest rates on fixed deposits.

Inflation has cooled off in the last few months, which may provide a leeway to the RBI to reduce rates. However, the RBI is likely to act not only on the basis of inflation, but also on the basis of economic growth rates. For example, economic growth rates tend to be slower when interest rates are high. In the present context, economic growth has slowed dramatically which may tempt the RBI to reduce the repo rate. Having said so, its always difficult to predict interest rates though broad indicators suggest that it would decline.

Bank fixed deposits look attractive

At the moment banks offer a very high rate of interest, perhaps matched only by company fixed deposits. However, company fixed deposits are not completely secure and do run the risk of defaults. Bank fixed deposits, particularly the public sector banks are relatively secured and hence the risk involved is far lower. In fact, several public sector banks like IDBI Bank, Union Bank and United Bank of India are offering good rates over the longer term.

However, its pertinent to note that bank interest rates are not exempt from tax and would have to be added to total income, when computing tax liability.

GoodReturns.in

Topics: rbi, interest rates, debt
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