The debate on whether interest rates on fixed deposits (FDs) have peaked or the door is still open for higher yields will continue well into 2024.

The recent bout of rate hikes by several banks indicates that the peak is not over yet. Or is it the last shower before 2024 and the time has come for you to lock in your FDs? 

The coast is not clear yet and depositors may be wrongfooted if they decide to move in this direction or that. No one knows for sure which way the wind will blow on deposit rates. 

There is more certainty on what the Reserve Bank of India (RBI) will do. The central bank will continue to press the pause button after last raising the repo rate by 25 basis points in February 2023. Unless, of course, inflation spirals upwards beyond control and needs to be tamed. A repo rate fall is also most unlikely well into 2024, after it climbed by 2.50 basis points to 6.50% through RBI’s aggressive series of interest rate increases since May 2022.

The shadow of a flattened repo rate may not entirely cast its influence on the deposit rates, at least for now. There are several reasons for the rates on deposits rising despite the RBI freezing the key policy rate. Credit is growing at a faster pace and banks are concerned about deposits trailing behind. Bank deposits are also having to contest with rising investments in a bullish stock market. There is gold, which is on a strong run on the backdrop of a weak dollar and the Federal Reserve’s reluctance to cut interest rates. The ongoing wars in Ukraine and Gaza are also leaving dark marks on the global economy and inflation.

Just as some analysts were expecting deposit rates to fall, the reverse happened. In the month of December, several banks hiked term rates as liquidity in the banking system got a lot tighter with credit growth outpacing deposit mobilisation. This led banks to borrow over Rs I lakh crore through the repo window of the RBI. 

The deficit was visible from the way banks participated in the first variable reverse repo (VRR) auction of the calendar year 2024. Conducted by the RBI, banks put in bids aggregating Rs 2,77,402 crore against the notified amount of Rs 1 lakh crore. This, in other words, was 2.8 times more than the offer.

As of 4 January, the system liquidity deficit was Rs 1.10 lakh crore. This was a far cry from the surplus liquidity that existed for nearly four and a half years since May 2019. 

The market witnessed system liquidity in deficit mode for the first time in September 2023 and this continued in December. Due to back-to-back advance tax payments and monthly GST payouts, the net deficit in banking system liquidity crossed Rs 2.5 lakh crore in the last week of December. 

Treasury experts say the situation could ease with some of the government bonds maturing towards the end of this month and the expected pickup in government spending. 

According to India Ratings and Research (Ind-Ra), the liquidity condition is expected to improve meaningfully from January 2024, owing to a surge in government spending ahead of the vote on account. Besides, foreign portfolio investment inflows into the equity and debt markets in December surged to a multi-year high of Rs 10 lakh crore in a month.

It is expected that foreign liquidity of $20 billion will flow into government bonds. This is expected to ease the liquidity pressures through a combination of new money supply and unwinding of government securities, specially by foreign banks in India whose invested book bulged by 50% over the previous year.

There is a structural change happening in the marketplace. While deposits have grown slower than credit in 2023, the Indian equity market has seen a massive flow of investments. The assets under management (AUM) of the mutual fund industry has crossed the Rs 50 lakh crore mark in December, with the last Rs 10 lakh crore being mopped up in just 13 months. In fact, the AUM added Rs 40 lakh crore in nine years. 

The inflows via systematic investment plans (SIPs) stood at Rs 1.84 lakh crore in the calendar year 2023, after December saw a mobilisation of Rs 17,610 crore. The SIP AUM has hit Rs 9.95 lakh crore in December, up from 9.31 lakh crore a month ago.

Banks need to worry on the huge traffic of money the capital market is attracting in India. The recent activity of banks on the deposit front has been more on the shorter maturity bucket, but the longer period deposits aren’t left untouched. Expecting the liquidity situation to ease after some of the government bonds mature this January, banks are increasing interest rates particularly on the shorter duration deposits. 

Bank of Baroda, which raised rates on domestic retail term deposits by up to 125 basis points in late December, said the increase is largely focused on shorter-term maturity buckets, specifically those less than one year. While the highest increase of 125 basis points came on deposits in the 7-14 days tenor to 4.25% (from 3% earlier), the lowest of 10 basis points was on three tenors within the 1-2 years period from 6.75% to 6.85%. The state-run bank said it is looking to increase its share of shorter duration retail term deposits.

“With the RBI maintaining a tight liquidity, securing funds for growth will be challenging for banks. If the central bank had normalised the CRR (cash reserve ratio) by bringing the requirement down to 4% (the ratio in normal times) from the current 4.5%, then immediately Rs 200 lakh crore would have flown into the banking system. But the RBI has to also balance inflation,” said Federal Bank chief mentor Ashutosh Khajuria.

Sensing that the tight liquidity situation could last longer, banks have been busy working on their deposit rates. Punjab National Bank (PNB) has twice raised interest rates this month on amounts below Rs 2 crore. The state-owned bank first hiked rates up to 45 basis points on certain tenures, effective 1 January. Now, effective 8 January, it has increased rates by 80 basis points on a single tenure. For deposits maturing in 300 Days, the rate on offer is 7.05%, up from 6.25%.

Federal Bank has revised its deposit interest rates, offering 7.50% to both resident and non-resident deposits on 500-day deposits since 5 December. “The cost of funds is rising for banks with most of them raising rates on their term deposits. There is a deluge of funds flowing from the savings accounts to the term deposits,” said Khajuria.

Analyst firm Jefferies said in its report that this is in part aided by improved GDP growth and shift to financial savings as against gold and land. With this, the wedge between the banks’ credit growth and deposit growth has more than halved to 300 basis points from 700 points in the year-ago period. The report noted that the gap is still negative and securing funds for growth will remain a key challenge for lenders.

 Jefferies said that meeting with banks in the past weeks indicated that there is little visibility on easing liquidity conditions. Hence banks continue to focus on ramping up retail deposit mobilisation at branches offering higher rates and factoring slightly slower loan growth in their business plans.

Over the last few weeks, lenders such as State Bank of India (SBI), Union Bank of India and Kotak Mahindra Bank have hiked rates on domestic and NRI retail term deposits of less than Rs 2 crore by 10 to 75 basis points across maturities.

SBI, India’s largest bank, has introduced the highest increase of 50 basis points on deposits maturing between 7 to 45 days (from 3% to 3.50%) and 180 to 210 days (5.25% to 5.75%). A 25-bps was introduced in three maturity buckets – 46 days to 179 days (from 4.50% to 4.75%), 211 days to less than 1 year (5.75% to 6%) and 3 years to less than 5 years (6.50% to 6.75%).

SBI chairman Dinesh Khara said the bank is hiking its deposit rates to give a fair deal to its depositors. The lender has also started a special 400-day Amrit Kalash FD scheme where it is offering 7.10% till March 2024. 

Union Bank of India has raised interest rates by up to 25 basis points on FDs on certain tenures for amounts less than Rs 2 crore, with effect from 27 December. The state-owned bank is now offering an interest rate ranging from 3% to 7.25% on FDs maturing in seven days to ten years.

Due to the merger of HDFC Ltd with HDFC Bank, about Rs 6 lakh crore of loans have come into the banking system. This is pushing up the loan growth figures. The incremental deposit growth was Rs 17.5 lakh crore between March and December 2023, rising by 9.7% over the same time last year. While bulk deposits grew by 6.4%, term deposits saw a 10% leap, according to RBI data for the fortnight ended December.

Excluding the HDFC merger impact, the deposits have risen by Rs 16.2 lakh crore or a rise of 9%. In the year-ago period, deposits had risen by 5.4% or by Rs 9.3 lakh crore.  

 The RBI data showed that lending during this period, including the impact of HDFC merger, has gone up by 15.6%, implying an incremental credit growth of Rs 21.3 lakh crore. Excluding the merger, the credit growth was 11.4% or Rs 15.5 lakh crore. In the year-ago period, lending was higher by 10.6% or by Rs 12.6 lakh crore.

“During this period investments increased by Rs 4.4 lakh crore (Rs 5.45 lakh crore including HDFC). Hence on the assets side, there was an increase of close to Rs 20 lakh crore (excluding HDFC) while deposits increased by Rs 16.2 lakh crore. This explains the persistent liquidity deficit in the system witnessed for over a month now,” said a report from Bank of Baroda.

Even if the RBI doesn’t raise repo rates and keeps it where it is today, banks will need to work on raising deposit rates. Unless, of course, the RBI starts the cycle for interest rate cuts to make borrowing cheaper. The market battle for deposits is not going to end soon.

.