Budget 2016 – Impact on Small Savings Schemes

The Small Savings Schemes segment witnessed some radical changes in the month of February this year, when the Finance Ministry announced a cut in interest rate in short-term schemes so as to align them with market rates of related government securities (G-Secs). Another notable announcement was the review of interest rates of such schemes every quarter, which will make it easier for consumers to benefit from rate cuts of the RBI. Long-term instruments, such as Monthly Investment Scheme (MIS), Public Provident Fund (PPF), and senior citizen and girl child plans, have, however, been left untouched.

The products that are commonly referred to as Small Savings Schemes include Post Office Savings Bank accounts, Post Office Time Deposits (duration of one, two, three and five years), Post Office Recurring Deposits, Kisan Vikas Patra, and National Savings Certificate (NSC), among others.

The changes will be effective from April 1, 2016.

What does the revamp entail?

Post office time deposits with tenures of one year, two years, and three years will not enjoy the spread of 25 basis points (bps) that they have over comparable tenure G-Secs. Presently, post office savings of one, two and three-year term deposits and five-year recurring deposits bear an interest rate of 8.4 per cent interest per annum. The Kisan Vikas Patras (KVPs) have an effective interest rate of 8.7 per cent per annum.

Following the government’s decision, they will fetch around 8.15 per cent and 8.45 per cent, respectively. However, the rates for the April-June quarter will be decided this month (March), as, in keeping with the new government directive, they will be based on the prevailing market rate in any given quarter.

Schemes such as Sukanya Samriddhi Yojana (girl child scheme), Senior Citizens Savings Scheme and MIS, which presently have 0.75, 1 and 0.25 per cent higher interest than G-Secs, will continue to enjoy the advantage as they are linked to social security goals. Besides, long-term instruments, such as five-year term deposits and similar tenure National Savings Certificates and PPF, will also not see any change, as these schemes are relevant to the self-employed, professional and salaried classes. However, they will also face a quarterly reset. As of now, PPF bears an interest rate of 8.7 per cent, while the Sukanya Samriddhi Yojana and MIS command a 9.2 per cent and 8.4 per cent interest rate, respectively.

Additionally, as per the directive of the Finance Ministry, the biannual compounding of interest allowed for ten-year NSC, five-year NSC and KVP shall be done on an annual basis from April 1, 2016. This, effectively, means a reduction of the interest rate of these instruments as well.

Why the changes?

The changes are aimed at enabling the transmission of RBI’s interest rate cuts to end consumers and link the returns of small savings instruments to the market rate prevailing on G-Secs. The small savings interest rates are perceived to limit the banking sector’s ability to lower deposit rates in response to the monetary policy of the RBI. The Finance Ministry, in its press communiqué, said: “This is expected to help the economy move to a lower overall interest rate regime eventually, and, thereby, help all, particularly low-income and salaried classes.”

Several economists have termed the move as inevitable. “This is important in several ways. If you want to keep all interest in the system at market rates, you can’t keep some regulated. The banks have been saying that some schemes such as the small savings schemes have higher rates, and so that makes it difficult for them to transmit the RBI’s interest rate cuts. This market-linking should at least remove that difficulty,” the Chief Economist of Crisil, D K Joshi, told The Hindu.

So, is it all for the better?

As per the RBI, deposits under all the savings schemes put together totaled Rs 6.28 lakh crore, as of May 2015. This included funds allocated to deposits, certificates and PPF schemes. The funds under the schemes that are going to be affected by the revision of rates amount to Rs 2.54 lakh crore – more than 40 per cent of all funds invested in all the schemes.

The market-linking of the returns of these schemes could mean that their rates of return fall significantly below their current levels. Cutting the rate of small savings schemes can save the government almost Rs 1250 crore per year, but the move is likely to irk small savers who could see their earnings drop. In addition to being politically unpopular, this is also likely to inconvenience people in rural areas where few banks have branches.

Whether this will turn out to be a wise move or yet another roll-back measure will have to be seen. Wait and watch this space.

Suneeta Kaul is a journalist, a writer, and a blogger. She tracks the economy, the corporate sector and the stock markets, and is a keen follower of current events. Having started her career with The Economic Times, she has worked for publications such as The Asian Age, Business India, and Thomson-Reuters, among others.