In 2025, the Reserve Bank of India reduced its benchmark repo rate—the rate at which it lends to commercial banks—by 100 basis points, from 6.50 per cent to 5.50 per cent. This move benefits borrowers by lowering borrowing costs but poses challenges for savers, as banks have started reducing interest rates on deposits.
India’s largest lender, State Bank of India, now offers 2.5 per cent interest on savings account balances. Private sector banks like HDFC Bank and ICICI Bank have followed suit, also cutting savings account rates to 2.5 per cent. This trend extends across public and private banks, with fixed deposit rates also declining in response to the RBI’s policy.
For savers, this raises a critical question: where can surplus funds, especially for short-term needs or emergencies, be parked to achieve better returns? Liquid funds and arbitrage funds emerge as compelling alternatives to traditional savings accounts.
Liquid funds, a category of debt mutual funds, invest in short-term fixed-income instruments such as government securities, treasury bills, and commercial papers, typically maturing within 91 days. This short duration minimises interest rate risk, while fund managers prioritise top-rated securities to reduce default risk.
Key advantages of liquid funds include:
High liquidity: No exit loads, with many fund houses offering instant redemption, allowing funds to be transferred to your bank account almost immediately.
Competitive returns: Liquid funds have historically delivered annual returns of 5 to 7 per cent, surpassing the 2.5 to 2.75 per cent offered by savings accounts, even on a post-tax basis.
Low risk: Their focus on short-term, high-quality securities ensures minimal credit and interest rate risk.
Liquid funds are widely used by corporations to park excess cash, with inflows fluctuating based on needs like quarterly tax payments. For instance, in April 2025, liquid funds saw inflows of Rs1.19 lakh crore, followed by outflows of Rs40,205 crore in May and Rs25,196 crore in June. Individual investors can similarly use liquid funds to park surplus funds or set aside money for short-term goals.
“Liquid funds are an excellent alternative to savings accounts and fixed deposits, offering slightly higher returns, penalty-free withdrawals, and greater diversification,” says Jiral Mehta, senior research analyst at FundsIndia. “They are ideal for building an emergency fund due to their low credit and interest rate risk.”
Arbitrage funds, another low-risk option, capitalise on price differences between the spot and futures markets. For example, a fund may buy a stock in the spot market and simultaneously sell it in the futures market at a higher price, locking in the difference—known as the arbitrage spread. This spread is influenced by short-term interest rates and market liquidity, with higher borrowing costs widening the spread and increasing profitability.
“Arbitrage funds are a low-risk haven for conservative savers seeking better returns than traditional assets, with the added benefit of equity taxation without holding open equity positions,” says Sailesh Jain, fund manager at Tata Asset Management. Since buy and sell prices are locked in simultaneously, these funds carry minimal price risk, and volatility can enhance returns.
In 2025, arbitrage funds have seen growing interest, with inflows of Rs11,790 crore in April, Rs15,702 crore in May, and Rs15,585 crore in June. “Arbitrage funds have delivered competitive returns over the past few years, making them a reliable choice for conservative investors,” says Jain.
Both liquid and arbitrage funds currently offer average annual returns of around 6 per cent, significantly outpacing the 2.5–2.75 per cent from savings accounts and therefore making the opportunity cost of leaving funds in savings accounts quite steep. However, their tax treatment differs:
As debt funds, liquid funds are taxed based on the purchase date. For units bought before April 2023 and held for over two years, long-term capital gains (LTCG) are taxed at 12.5 per cent. For units bought after April 2023, gains are taxed as per the investor’s income tax slab, regardless of holding period.
Treated as equity funds, arbitrage funds attract a 12.5 per cent LTCG tax if held for over one year, making them more tax-efficient.
“Arbitrage funds, while slightly less liquid, offer a tax advantage, making them ideal for investors in higher tax brackets,” says Ankit Patel, co-founder and partner at Arunasset Investment Services.
Liquid funds are ideal for those prioritising liquidity and stability, especially for emergency funds or short-term parking of money. Arbitrage funds, while slightly less liquid and more volatile over very short periods, offer better post-tax returns for holding periods of six months to a year. “Investors should consider a minimum six-month horizon for arbitrage funds due to their slightly higher volatility compared to liquid funds,” says Mehta.