How Does Inflation Affect FD Interest Rates?

Of late, a lot of debate has been making rounds in various circles, as to whether the interest rates offered by banks on fixed deposits (FDs) will turn out to be sufficient in the long run. By sufficient, we mean if the interest rates that are currently offered would, in future, still stay higher than the rate of inflation in India considering its current rise. To learn more, consider how inflation affects FD interest rates.

How is inflation caused?

Inflation is the increase in the prices of goods and services throughout the economy. Companies are bound to start paying higher wages when the unemployment rates fall. It ultimately leads to an increase in production costs, which invariably leads to the consumer being charged higher prices for goods and services.

How does inflation affect fixed deposit interest rates?

The current fixed deposit rates might seem like a good option that would work out shortly. However, this might not be an ideal way of saving money in the long run if the inflation rate is higher. Here’s an example for better understanding:

If you earn an interest rate of 6.5% through a fixed deposit, but the inflation rate is set at 7.5%, the money you save will not be sufficient to match the rising inflation. Do note that the interest income earned from fixed deposits can also be taxed, lowering the returns compared to the inflation rate. Therefore, it is essential to look for investment avenues that offer returns that can beat the prevailing inflation rate.

Is it a good idea to invest in fixed deposits?

Fixed deposits are one of the safest options when it comes to investing money. This is because the fixed deposit interest rates are fixed, so investors know the exact returns they can earn once the fixed deposit matures. Of course, tax getting deducted from the returns and higher inflation rate are a few downsides to this investment option. However, you can effectively deal with these problems by maximising your returns from fixed deposits.

Here are a few ways in which you can get maximum returns from fixed deposits:

1. Avoid withdrawing funds before the FD matures

It is never a good idea to withdraw funds from a fixed deposit before it matures. This is because the withdrawals reduce your interest income, not to mention the penalty banks charge for early withdrawals.

2. Renew your fixed deposit after each term

Short-term fixed deposits can be very effective in helping beat inflation. So, it is considered best to keep renewing your fixed deposits every term. You can open a fixed deposit with IDFC FIRST Bank and earn up to 6.5% interest. IDFC FIRST Bank also waives any penalty charges for senior citizens if they withdraw funds from their fixed deposits before maturity.

Ultimately, you should choose an investment option based on your financial goals and risk appetite. If you are willing to take on more risk, there are several market-linked investment options that you can consider for establishing a diversified portfolio.

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