Fixed Deposits: Evergreen choice for conservative investors

Parvatha Vardhini C Interest rates may wax and wane, but the good old bank fixed deposits (FDs) never completely go out of flavour for conservative investors. While not as safe as sovereign-backed instruments such as the post office schemes or bonds issued by the government, they are still safer than market-linked products such as debt mutual funds.

Besides, a safety net is also available in the form of deposit insurance cover. The deposit insurance cover per bank (including small finance banks, or SFBs) was increased from the ₹1 lakh earlier to ₹5 lakh in the recent Budget. This implies that your holdings of up to ₹5 lakh (including principal and interest) in all forms of deposits (savings or current A/C, FD, RD, etc) across branches of the same bank are backed by insurance, should anything go wrong with the bank.

Remember, NBFC deposits don’t have this cover. Hence, you can park a portion of your investible surplus in bank deposits without losing sleep.

That said, FD interest rates are not at their best now. Even before the Covid-19 pandemic set in, interest rates were in benign territory. Loan growth had taken a back seat and banks were in no hurry to raise fresh money in the form of deposits.

The problem is now accentuated. A prolonged economic slowdown as a fallout of the pandemic could continue to keep deposit interest rates soft for some more time. Also, there is uncertainty regarding the exact impact of the pandemic on banks’ loan books.

Given this scenario, it would make sense to lock into short-term deposits of 1- 2 years now. On maturity, you can take a call based on the prevailing rates then, as well as the performance metrics of banks. The 18-month deposit of DCB Bank which offers 7.5 per cent, and the one- to two-year deposit of Ujjivan Small Finance Bank offering 8 per cent are two of the best options available now.

With both banks, senior citizens get 0.5 per cent extra. Both offer a cumulative (quarterly compounding) as well as a regular payout option.

DCB Bank

The interest rate offered by DCB Bank is superior to public sector banks which offer only 5.7-6.2 per cent in the one- to two-year time bucket. Among private sector banks, YES Bank and IDFC First Bank do offer the same 7.5 per cent for the same time period. But given that the former is sailing in rough waters and the latter is a merged entity with only a short history of the merger (2018), DCB Bank scores better.

As of December 2019, DCB Bank had a loan book of ₹25,438 crore. DCB’s gross NPA was at a reasonable 2.15 per cent and its liquidity coverage, at a comfortable 107 per cent. The bank is also adequately capitalised with tier I capital at 12.3 per cent and total capital adequacy ratio at 15.8 per cent.

You can open the FD online on the website of the bank using your Aadhaar and PAN, even if you don’t have an existing relationship with the bank. The minimum deposit is ₹10,000.

Ujjivan SFB

For investors with a slightly higher risk appetite, Ujjivan offers a higher interest rate of 8 per cent on a one- to two-year deposit. SFBs are considered riskier due to their business of lending to the vulnerable sections, where risk of default could be higher.

However, Ujjivan scores on financial metrics. As of December 2019, its gross loan book stands at ₹13,617 crore and gross NPAs at 0.9 per cent.

Its total capital adequacy ratio is at 28.3 per cent, with tier I capital at 27.5 per cent, thanks to its recent listing. The bank also has a wider reach, which is not the case with all SFBs.

Ujjivan operates through 574 branches spread across 244 districts and 24 States and union territories in India.

The minimum deposit is ₹1,000. You can open a deposit through mobile or net banking. If you are new to the bank, fill out an enquiry form on the bank’s website to get in touch with a representative.

NSC: Safe and sound

The five-year National Savings Certificate (NSC), a small savings scheme offered by the post office, is a good choice for those seeking a no-risk, medium-term investment with sound returns.

Recently, the rate on the NSC was cut sharply from 7.9 per cent pa in the January-March 2020 quarter to 6.8 per cent pa in the April-June 2020 quarter.

Tax breaks add to effective returns

Still, it remains a good investment for those in the old tax regime (that has tax breaks) who have not exhausted their investment limit under Section 80C (up to ₹1.5 lakh a year).

For such folks (in the 20 per cent and 30 per cent tax slabs), the NSC is a good choice for many reasons.

One, the five-year NSC currently offers higher interest rates than most bank fixed deposits (5.5-6.5 per cent). Each investment in the NSC will earn the interest rate at opening (6.8 per cent during April-June 2020) until maturity. Two, the NSC carries zero risk — thanks to government guarantee. Three, the investment is open to all — all resident Indians can invest in the NSC. Four, you can invest any amount in the NSC — the minimum is ₹1,000, you can invest in multiples of ₹100, and there are no caps. But the deduction under Section 80C is restricted to ₹1.5 lakh a year across investments, including NSC.

Five, the money is invested for a reasonable time period — five years — and is not locked in for too long.

Six, being a cumulative instrument that compounds interest annually, the NSC can help build a good corpus at the end of the five-year period.

Finally, the NSC can deliver healthy effective returns, thanks to the Section 80C tax break on the investment and also on the interest for the first four years that is reinvested. So, only the last year’s interest is taxable. Considering the tax breaks, the post-tax effective annual return on the NSC can be in the early to mid-teens for those in the 20-30 per cent tax slabs.

There is no tax deducted at source on the fifth year’s interest, but you must pay tax on it on your own.

Whom does it not suit?

But the NSC may not be a good choice for some folks.

One, for those in the 5 per cent tax bracket, the effective return on the NSC is the same as the interest rate — the Section 80C tax break doesn’t add to returns since the full rebate benefit means they anyway don’t have to pay tax.

Next, if you are in the old tax regime but have exhausted your Section 80C limit without the NSC investment, the effective return will not be enhanced by investing in the NSC. Tax will apply on the interest earned (currently 6.8 per cent) and the post-tax return will be 5.4-4.7 per cent (for those in the 20-30 per cent tax slabs).

Also, for those choosing the new tax regime, with no tax break under Section 80C, the NSC’s returns fall.

The pre-tax return (6.8 per cent currently) will be taxable, and so the post-tax returns comes down to 6-4.7 per cent for those in the higher tax slabs (10-30 per cent).

In such cases, you may be better off with other higher-yielding options such as GOI bonds or deposits of small finance banks.

Also, for those seeking periodic payouts, the NSC is not suitable as it is a cumulative instrument.

Investors can get loans against NSC though, if the need arises.

Protect your capital with tax-free bonds

The persisting instance of credit-quality issues with debt instruments over the past two years has been haunting the Indian fixed-income markets. The recent episode of winding-up of six debt schemes managed by Franklin Templeton India Mutual Fund has rattled retail investors, with capital safety now becoming a prime concern.

Investors looking for debt instruments that provide capital safety and decent returns can consider tax-free bonds available in the secondary market. These are also suitable for those wanting regular income on a yearly basis.

A total of 193 series of tax-free bonds issued by 14 infrastructure finance companies from FY12 to FY16 are listed on the bourses. They are traded in the cash segment on BSE and NSE.

These tax-free bonds were issued by public sector undertakings and public financial institutions backed by the Central government. Hence, the investments made in these tax-free bonds enjoy capital safety.

Secondly, the bonds issued by most of these companies are rated with the highest grade of AAA. Instruments with AAA rating are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry the lowest credit risk.

What’s in store?

While investing in tax-free bonds through the secondary market, investors should not just look at the coupon rate and the market price of the bonds.

There are three parameters that they should consider — credit rating, YTM and liquidity.

Going by the data compiled by HDFC securities, there are a handful of tax-free bonds with good credit rating that trade with relatively high volumes and also offer reasonable YTMs (yield-to-maturity) in the secondary market (see table). These include the series bonds of HUDCO, REC, PFC and NHAI.

For instance, the HUDCO N3 series (ISIN INE031A07832), with a coupon rate of 8.1 per cent and a residual maturity of 1.9 years, trades with a YTM of 5.2 per cent on NSE. Since the interest paid by tax-free bonds are exempt from income tax, the current yield of 5.2 per cent translates to 7.4 per cent pre-tax yield for investors in the 30 per cent bracket. This rate is relatively high than those offered by bank fixed deposits currently.

How to buy

Both BSE and NSE facilitate the purchase and sale of tax-free bonds.

They are listed and traded in the cash segment along with equity shares. Retail investors can buy and sell tax-free bonds through demat accounts.

RBI bonds for risk-free, attractive returns

With the recent volatility in the equity market and the turmoil in debt funds, you may be looking for an investment safe haven with reasonable returns. You can consider 7.75 per cent savings (taxable) bonds, 2018, also known as RBI savings bonds.

These bonds are one of the safest investment options as they are issued by the RBI on behalf of the Central government.

As the name suggests, RBI savings bonds offer an interest rate of 7.75 per cent.

They have a tenure of seven years and come with cumulative and non-cumulative (half-yearly interest payment) options.

In the present scenario, where the repo rate is headed downwards, RBI savings bonds score higher than most other fixed-income options. For five-year fixed deposits (FDs), while private sector banks offer 6-7.5 per cent, public sector banks offer a lower 5.5-6.1 per cent per annum. Though a few small finance banks offer higher rates of interest, the limited presence of these banks could be a deterrent.

For the new regime

RBI savings bonds also look more attractive than similar-tenure post office savings schemes. With half-yearly compounding, the yield on the cumulative bonds comes to 7.9 per cent, better than National Savings Certificate (6.8 per cent) and five-year term deposit (6.87 per cent), without considering tax breaks. Thus, you will be better off — in terms of returns — investing in RBI savings bonds if you move to the new tax regime, under which tax breaks are not available, but income is taxed at lower rates.

Even if you are sticking to the old tax regime, these bonds can be considered after you have exhausted your Section 80C investment limit or your income is within the tax-exempt limit of ₹5 lakh. Investment in these bonds are not eligible for tax benefit under Section 80C of the Income Tax Act. Interest income, too, is taxable as per the investor’s income-tax slab rate.

Individuals and HUFs (Hindu Undivided Families) are eligible to purchase these bonds with a minimum investment of ₹1,000 and with no upper limits. Note that non-resident Indians are not allowed to invest in them.

You can buy these bonds from the Stock Holding Corporation of India (online option available) or any of the nationalised banks or private sector banks such as ICICI Bank, HDFC and Axis Bank.

They can also be bought through a trading account maintained with your broker.

The downside of investing in RBI savings bonds is that you should lock in your investment for seven years. These bonds are neither tradable in the secondary market nor transferable.

However, for those in the age brackets of 60-69, 70-79, and 80 and above, the lock-in period is six, five and four years, respectively.

Even so, the penalty for pre-mature withdrawal after the lock-in period is 50 per cent of the interest due and payable for the last six months of the holding period.