Interest rates have been on a free fall in 2016, be it bond yields, rates on bank deposits or small savings schemes. The RBI’s rate easing, its decision to move to a liquidity neutral regime and the more recent demonetisation drive by the Centre triggered the unexpected fall in rates, bringing cheer to bond investors, but pain to depositors. Will rates move lower in 2017?

With growth in the economy still a concern and inflation moving lower (for now), the RBI will likely persist with its accommodative stance. But rate cuts from hereon will be limited. For one, since the beginning of January 2015, the RBI has lowered its key policy rate by 175 basis points in all. At best, there is headroom for another 25-50 basis points rate cut in 2017. Two, if the US Fed turns aggressive with its rate hikes in 2017, the RBI may go for a more measured cut. Three, in the ensuing months, if there is ample liquidity in the system, after currency flow normalises, the RBI may not conduct OMOs — buying of government bonds — at the same pace as last year, capping the fall in bond yields.

With only an ‘if and but’ reduction in rates, here are three themes that investors in the fixed income category can ride on in 2017.

Shop for attractive rates 2016 has been a forgettable year for those who swear by bank FDs. Across tenures and banks, deposit rates fell by around 125 basis points in 2016. While such a steep fall is unlikely, going ahead, banks will continue to trim deposit rates.

If you prefer the safety of bank deposits, you can still shop for attractive rates. A tenure of upto two years would be ideal as it would help tide over reinvestment risk. At the same time, after rates bottom out over the coming year or two, you can get yourself on the rate rise bandwagon. In the one to three-year category, Bandhan Bank offers a higher rate of 7.5 per cent. You can also look to lock into attractive rates offered by NBFCs and companies. AAA-rated (two-year) deposits from Dewan Housing Finance offer 8.3 per cent currently.

Stick with small savings The Centre brought the axe down on the humble post office schemes, slashing rates by 40-130 basis points across schemes, effective April-June 2016 quarter. The Centre will now revise these rates every quarter based on the prevailing rates on G-Secs. Fortunately, after the steep cut in the first quarter, the Centre has only tinkered with rates.

For now, National Savings Certificate (NSC) and the five-year post office time deposit score over five-year bank deposit (tax-saving). While the tax break under Section 80C is available for all, tax liability on the interest earned differs. Interest earned on bank deposits as well as post office deposits is taxed at your slab rate. Hence, five-year post deposit that earns you 7.8 per cent clearly trounces bank deposit offering 7.5-7.75 per cent (best rate). In the case of NSC (offering 8 per cent), interest earned is accumulated until the fifth year and eligible for tax exemption. If you want to park money for 10 years, PPF offering 8 per cent interest (tax free), is still the best option. But do note that these schemes still carry the risk of sharper rate cuts in the coming year. Lock into fixed rate products such as NSC and time deposit before rates head lower. Rates on PPF can vary each quarter. Do keep this in mind before making fresh investments.

Keep bonding Bond markets have been on roll in 2016, with yields on 10-year G-Secs falling sharply by nearly 1.5 percentage points. From hereon, upside will be limited for bond investors.

But this does not mean that investors should shun debt funds altogether. Investors willing to take some market risk should invest in debt funds that offer far better returns than plain Jane bank deposits.

A chunk of your debt fund investments should be in short-term income funds that carry less volatility in returns. Stay clear, though, of funds holding lower rated bonds. A small portion can still be parked in long-term gilt funds. This will allow you to cash in on a sudden rally in bond prices. If you are still averse to taking interest rate bets, opt for dynamic bond funds that can switch between short-term and long-term debt instruments.

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