Quarterly review: What’s changing in Prime Deposits

These are extraordinary times for fixed income investors. Interest rates, after recent rate cuts by the MPC, are ruling at lows not seen in the last two decades. The repo rate of 4.4% today is even below levels seen during the global financial crisis.

With policy rates and market interest rates falling, banks have slashed deposit rates and the Government has effected steep cuts in the small savings rates for the April 1 to June 30 2020 quarter. At the same time, the lock-down and its impact on borrowers makes this a dicey time to take on any kind of risk with your fixed deposit investments.

Keeping all this in mind, we have made significant changes to our curated list of deposits. Here are the three key sets of changes to the list and why we made them.

# 1 Replacing post office deposits with bank FDs

After holding on to high interest rates on its small savings schemes for the last three quarters, the Government has over-compensated on March 31 by slashing these rates drastically for the coming quarter, from April 1 to June 30 2020. Therefore, post office time deposits have seen a 100-110 basis point reduction in rates, the Monthly Income Scheme has seen a 100-basis point cut and the Senior Citizens Savings Scheme has seen a 120-basis point decline.

We feel that this round of rate cuts has materially reduced the attractiveness of the post office time deposits as an investment option. The primary objective of any financial investment should be to beat inflation. Given that recent consumer price inflation rates in India have been at 5.5-7.5 per cent (the inflation you personally experience may be even higher), post office deposits would now yield a negative real return. Though rates on the post office monthly income scheme are slightly better at 6.6%, the five-year lock in period is a deterrent today.

We therefore replaced the post office deposits in Prime Deposits with deposit products from two of India’s leading banks – SBI and HDFC Bank. Apart from offering slightly better rates (still not matching up to inflation though), the digital interface possible with these banks and their better service levels make them better choices compared to post office deposits, at this juncture.

We believe that the coming months will be quite stressful for smaller banks and lenders, and therefore recommend playing it absolutely safe with your choice of banks. This is not the time to park deposits with small finance banks or smaller private banks, though they may offer better returns.        

# 2 Pruning NBFC deposits

With most businesses in lock-down, salaried as well as self-employed folk may face a high risk of interrupted income in the coming months, which in turn poses a risk to loan repayments. The moratorium recommended by RBI to banks and NBFCs may also put these lenders in a tight spot, as one doesn’t know if the 3-month leeway on loan repayments will extend longer as borrowers take their repayments less seriously. With the defaults not to be recognised by CIBIL or rating agencies over the next three months, NPAs for banks and NBFCs from this lockdown may remain hidden in their financial disclosures too.

This makes this a very dicey time to lend money to NBFCs operating in the riskier lending areas such as vehicle finance, durable finance or unsecured loans, where loans have either been extended without collateral, or have been given with a depreciating asset as the collateral. Given these difficulties, we decided to play it safe by removing NBFCs such as Bajaj Finance and Mahindra Finance from our recommended list. We have stayed with Sundaram Finance and HDFC alone, given their solid managements who may not take on reputational risk despite tough business conditions. These NBFCs today offer substantially higher rates than both post office schemes and bank deposits, offering an opportunity to diversify.   

# 3 Restricting tenure

No matter how you view it, it’s a Hobson’s choice for fixed deposit investors today. If you want to avoid risk (which you should, in the circumstances), then you are forced to settle for ultra-low returns that don’t even match inflation. However, at times like this, investors do need to hold ready cash in deposit products that isn’t subject to equity or bond market volatility.

We therefore think that the best way for depositors to handle this situation is to park their deposit money today for the lowest tenures possible and wait for the current phase to pass. The COVID-19 crisis is unlikely to last beyond the next six months to a year and the ultra-low rates we’re seeing now are also unlikely to last. Investing in 5-year or more fixed income products such as the POMIS, NSC or post office time deposits at current rates will mean unnecessarily locking into these exceptionally low returns.      

This is the key reason why we’re knocked off all deposits for more than 3-year tenures from our curated list. We have retained the Senior Citizen’s Savings Scheme alone because of its relatively better rates (7.4%) compared to prevailing bank deposit as well as market interest rates on government borrowings.

[Updated: The below section added on April 7, 2020]

What you should do

So if you already have deposits in riskier options such as private sector banks, small finance banks or NBFCs from our earlier recommendations, what should you do? Well, the answer will depend on how much of your portfolio is invested in the riskier options. We have already recommended that at times like this, it is best to play it absolutely safe with your emergency fund sticking to the top couple of banks such as SBI and HDFC Bank. For debt allocations beyond this, select your deposits from our current Prime Deposits list. If you have older deposits in NBFCs or small finance banks that do not find place in this table, ensure that they make up no more than 5% of your total portfolio (equity/debt portions included). If they do, liquidate the excess and switch to our recommended list. Staying within the boundaries of an asset allocation plan that is suited to your risk profile and keeping an emergency fund ready are absolutely essential at times like this.

The message for fixed deposit investors is simple. These are terrible times. Lie low, minimise tenure and wait for a turn in the rate cycle.