Time to keep it safe and flexible

In its efforts to spur economic growth following the Covid-19 pandemic, the RBI announced a sharp 75-basis point (bps) cut in the repo rate in March 2020, followed by another 40-bps cut in May. With this, the repo rate has come down from 5.15 per cent at the start of the year to 4 per cent now.

In line with this move, large commercial banks slashed their deposit rates by 70-160 bps over the past year or so. Small finance banks (SFBs) followed suit with cuts of 100-150 bps.

Rates on small savings schemes, which are reset quarterly, were slashed by 70-140 bps in the April-June 2020 quarter. Though, since then, rates have been left unchanged for three consecutive quarters. The Government of India 7.75 per cent Savings Bonds were closed for subscription in May 2020 and were replaced in July by the 7.15 per cent Floating Rate Savings Bonds.

Among debt funds, hurt by downgrades and defaults, many credit-risk schemes took a hit this year. While most liquid funds fetched one-year returns of 3.2-4.3 per cent in 2020, those in the short- and medium-duration categories returned 6-11 per cent.

What to pick

With interest rates at historic lows today, investors have been left wanting better investment avenues. With many businesses and the economy yet to fully recover from the impact of the pandemic, capital preservation remains top priority.

At the same time, the interest rate outlook is quite uncertain. While further cuts appear unlikely, so do near- term increases. This suggests investors are better off parking their debt money in products with ready liquidity, short lock-ins or floating rates. We highlight options that score high on returns, safety, ease of exit and tax benefits.

Fixed deposits: Despite the rate cuts, a few fixed deposits, especially from SFBs are offering good rates, at 6 -7 per cent on their one- to two-year FDs. These are particularly attractive for those in the lower tax brackets as interest on FDs is taxed at your income-tax slab rate.

Investors can consider the one-year-to-18-month FD from Equitas SFB, one of the healthier SFBs in terms of governance and capital adequacy. It offers 6.60 per cent per annum (7.10 per cent for senior citizens). Comparable FDs from public sector banks offer 4.9-5.3 per cent, while many from private sector banks offer 5-6 per cent.

Equitas SFB’s gross NPAs were 2.48 per cent and its tier 1 CAR (capital adequacy ratio) was at a comfortable 20 per cent as of September 2020. Investors can also consider DCB Bank’s 700-day FD that offers 6.9 per cent.All bank deposits have a deposit insurance cover of ₹ 5 lakh per bank.

Short-duration debt funds: These funds invest in debt and money market instruments such that the average portfolio maturity is under three years. The last seven years, leading schemes in this category have delivered average one-, three- and five-year rolling returns of 7.9 per cent, 5.0 per cent and 7.7 per cent, respectively. But going forward, returns will be lower given the low coupons on bonds currently.

If you want to play it safe, stick to only high-credit-quality funds. IDFC Bond Fund - Short Term Plan and Canara Robeco Short Duration Fund are two such schemes. As of November 27, 2020, the IDFC fund and the Canara Robeco fund had over 96 per cent and 97 per cent, respectively, of their portfolio in AAA and sovereign debt papers.

If held for over 36 months, long-term capital gains on debt funds is taxed at 20 per cent with indexation benefits, making them more attractive than fixed deposits for those in the higher tax brackets. Short-term capital gains (for investments redeemed within 36 months) are, however, taxed at your income tax slab rate.

Floating Rate Savings Bonds: If liquidity is not a concern, you can invest in the sovereign guarantee-backed Floating Rate Savings Bonds 2020 from the Central government that carry an interest rate of 7.15 per cent per annum currently. The interest rate is reset every six months and is paid half-yearly. The interest income is taxed at your income tax slab rate.

You can buy the bonds from SBI, other nationalised banks and some private sector banks. The only negative — a lock-in period of seven years. However, those 60 and above, are allowed pre-mature encashment after a few years, subject to a penalty of 50 per cent of the last interest payment.