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Navigating Rising Interest Rates: The Battle between FDs and Debt Mutual Funds

Updated: Jun 22, 2023

In the current scenario, where interest rates have been on the rise, investors are faced with a pivotal decision: Should they go with fixed deposits( FDs) or debt mutual funds?

FDs and Mutual funds

FDs and Debt Mutual Funds

Examining the Disconnect: Repo Rate Hikes vs. FD Rates

Let's delve into the specifics. Despite a substantial repo rate hike of 225 basis points, the FD rates offered by banks have not escalated proportionately. Take, for instance, the State Bank of India (SBI), which presented a FD rate of 5.20% for a one-year tenure in May 2022, before the rate hike cycle commenced. Surprisingly, by December 2022, the same FD only offered a rate of 6.75%, a mere 155 basis point increase. This discrepancy raises questions about whether banks are adequately passing on the benefits to the end users.

Bond Rates and their Intricate Relationship with Repo Rates

To comprehend this scenario further, we must explore the inverse relationship between bond rates and the repo rate. As the repo rate climbs higher, bond prices tend to plummet. Consequently, investors may witness lackluster returns from debt funds in recent times. However, does this mean that fixed deposits emerge as the undisputed winners in this complex equation? The reality is far from straight forward.

Unraveling the Complexity: Beyond Fixed Deposits

While it may be tempting to view fixed deposits as a safe haven, the full picture necessitates a closer examination. Other elements, such as inflation, taxation, and investment goals, must be taken into account when assessing the suitability of fixed deposits as an investment avenue.

Navigating the Fixed Deposit Landscape

1. The Incomplete Transmission of Repo Rate Benefits

In recent times, you might have observed that banks have not fully passed on the benefits of repo rate cuts to fixed deposit investors. Despite rate hikes initiated by the Reserve Bank of India, the transmission of these benefits to FD rates remains incomplete. This discrepancy prompts us to question the factors influencing the equilibrium between repo rates and fixed deposit returns.

2. The Potential for Future Rate Hikes

The rate hike cycle is an ongoing process, and experts speculate the possibility of another hike in the near future. While the exact timing remains uncertain, market forecasts suggest that an additional rate hike could be implemented as early as next month. This anticipation sets the stage for potential further increases in fixed deposit rates.

Implications and Expectations: Looking Ahead

Taking these factors into consideration, investors can draw a few conclusions regarding the fixed deposit market. Firstly, there is a strong likelihood of FD rates experiencing further upward movement in the future. This projection is based on the expectation of continued transmission of repo rate benefits and the potential for upcoming rate hikes. Even if rates don't rise significantly, it is anticipated that they will remain stable at their current levels for a considerable period.

Exploring the Potential of Debt Mutual Funds

In recent months, debt funds have faced a period of underperformance, as discussed earlier. However, as the repo rate increases, debt mutual funds can experience a positive impact, which investors can expect to witness in the coming quarters.

With the rise in the yield to maturity (YTM) of underlying bonds, the potential returns of debt mutual funds can improve. YTM represents the total return an investor receives if all scheduled payments are made on time and the bond is held until maturity.

Considering the current stage of the rate hike cycle, we are nearing the peak, or almost at the peak. In the near future, the rate hikes are expected to cease and might even begin to decline. Consequently, the negative impact on debt funds will fade away, and they are anticipated to regain their performance. This makes debt funds a viable consideration for investors.


Name of fund


One year return

Aditiya birla sun life low duration direct plan growth

11,774 crores


PGIM India low duration fund direct plan growth

102 crores


Sundaram low duration fund direct plan growth

102 crores


Nippon India low duration fun direct plan growth



HDFC low duration direct plan growth

​14,664 crores


The average returns of debt funds range between 6 - 7% but from the above table we can say that it has come down in the last one year.

The tax benefits

Before you pick any asset, you must factor in taxation to understand the actual returns.

In the case of fixed deposits, the interest you earn is added to your taxable income and taxed as per your tax slab. Therefore, if you are in the 30% tax bracket, your net returns are relatively low. However, if your tax slab is at the lower end, the actual returns can be high.

Earlier we use to get an indexation benefits with debt mutual funds but not any more. Amendment to Finance Bill 2023 scrapped the indexation benefit on debt mutual funds. They will now be taxed at investor’s slab rates. These changes will bring taxation of specified mutual funds at par with fixed deposits.

Which is the better option?

At present, given the uncertainty around FDs and debt mutual funds, there is no clear winner. Investors can pick one (or both) based on their investment horizon, goals and factor in taxation to see what gives the maximum returns.

However, given the uncertainty, it is better to opt for FDs or debt mutual funds with a short duration. In fixed deposits, if rates go higher, you can reap the benefits by investing at higher returns. For debt funds, select schemes with comparatively shorter duration profiles.

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