The demonetisation of big notes has swelled the offers of banks as people rush to deposit old notes. Banks have so far been able to attract deposits worth over Rs 5 lakh crore, according to the latest RBI data.
With credit offtake remaining weak, banks have been forced to cut deposit rates. SBI, for example, last week cut fixed deposit rates by up to 50 basis points, depending on the maturity of deposit and type of deposit, retail or bulk. Some banks have even cut their lending rates.
High bank deposits will put further downward pressure on the overall interest rate in the financial system, including on the fixed deposit rates.
"This huge amount of deposits has turned the system liquidity into surplus and we believe that this extra liquidity will not go away from the system in a hurry, which may push down the interest rate further," media quoted a top SBI official as saying.
Now, with food prices falling and the demonetisation of Rs 500 and Rs 1,000 bank notes set to put further downward pressure on inflation, the consensus is building up for a 25-50 basis-point rate cut from the Reserve Bank of India soon. The RBI's next policy meet is scheduled for December 7.
Expectations of lower inflation and a possible rate cut have already triggered a rally in the Indian debt markets, with bond yields falling to eight-year lows.
According to Value Research data, the average return of debt mutual funds in debt funds (gilt medium and long term) has been around 2 per cent in the past one week, taking their yearly return around 15 per cent. Analysts expect the rally in debt mutual funds to continue at least in the medium term, with RBI cutting rates further.
Manoj Nagpal, CEO of Outlook Asia Capital, says conservative investors should lock into fixed deposit rates of higher maturity if they want a recurring monthly/annual income as interest rates are likely to fall further.
Alternatively, he suggests young investors to move to long-term debt mutual funds if they want to take benefit of the waning interest cycle. Debt or bond markets benefit from a downward trending interest rate cycle.
Mr Nagpal also recommends senior citizens to get lock into higher rates provided by the Senior Citizen Savings Scheme, even though the interest rates in small savings schemes are likely to dip following an overall downward trend in the interest rate cycle. However, small savings schemes typically provide higher interest rates than bank deposits.
Vikram Dalal, managing director of Synergee Capital, says investors can also look at "tax-free bonds, which offer six per cent tax free return with no lock-in period (pre-tax return for 30 per cent tax bracket investors will be nine per cent". Tax-free bonds were a huge hit among investors who looked for a steady tax-free interest income but this fiscal year, there would not be fresh issues of tax-free bonds. Since tax-free bonds are traded on exchanges, investors can buy them from secondary markets.
"While investing in tax-free bonds, one should consider tenure, rating and liquidity," he adds.
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