Savers are a neglected lot

S S Tarapore

Reddy committee report is about reducing the cost of government borrowing

On April 19, 2001 the Indian government constituted an Expert committee to review the system of administered interest rates and other related issues with deputy Reserve Bank of India governor, Dr Y V Reddy as chairman. When the Reddy committee submitted its report on September 17, 2001, the hopes and aspirations of savers were dashed as the committee was essentially an instrument to pursue the one point agenda of reducing the cost of government borrowing.

It would be unfair not to concede that the report undertakes a tour de force on the system of administered interest rates and calls for a wider public debate on issues involving the stakeholders. Despite the highly competent analysis, the report somehow nose-dives into inflicting punishment on savers by reducing interest rates.

The issue of who is the stakeholder needs to be considered. In India, in the recent period, the only stakeholder who seems to count is the borrower who, in the present case, is the government and the central issue seems to be of sharing the spoils between the centre and the states. The impact of the recommendations on savers appears to be of a lower order of priority.

While reviewing what the report calls Critical evaluation of issues, what looms large is the commitment to reduce the overall fiscal deficit, productive use of funds and the need to develop the debt market. Having said this the committee pays homage to “the centrality of the interests of the savers in terms of providing a risk free real return for retail savers with special emphasis on old age security”. The committee has focused its recommendations on small savings schemes and the Public Provident Fund. It recognises that as the financial system is progressively deregulated, administered interest rates should be aligned with market rates of interest.
Various issues such as inculcating the habit of thrift, the rural-urban divide, the distortion caused by fiscal privilege and the asset-liability mismatch of the borrower (centre/states) are discussed. It is also rightly argued that the savings schemes are in the nature of Ponzi schemes which inevitably explode.

The committee correctly stresses the need for benchmarking administered interest rates. After considering various benchmarks, such as the inflation rate, bank deposit rate, bank rate and the yield on ten-year government securities, the committee opts for the yield on ten-year government securities with an annual reset. This is unexceptionable.

The horror story for savers starts after settling the benchmarking. The use of a weighted average of ten years with a distributed lag (with higher weights for the recent period and lower weights for the more distant period) is rejected by the committee as the weights tend to be subjective. The committee recognises that “a stable benchmark rate is that which fluctuates within a narrow range and has a low coefficient of variation”. There is, however, more than meets the eye as the committee is consummated by the government’s passionate desire to bring down interest rates at all costs.

Let us look at the PPF which extends to a period of 15 years. When a saver voluntarily subscribes to a ten-year government security at a coupon rate of say, 9.5 per cent, he is assured this rate through the life of the security. Now if the PPF is benchmarked to the average secondary market yield during the previous year, the interest rate on the entire PPF balance will go up or down. Our experience is that the ten-year security has ranged over the past decade between 14 per cent and 9.5 per cent. So holders of PPF will have to play blind and face volatile movements in the interest rate on their balances. Surely the committee could have considered a weighted average with a standard distributed lag, with weights of 10 going down to 1 for years t-1 to t-10.

The whiz kids in the RBI could have also come up with more sophisticated formulae. But what the saver would have easily understood is a straight ten-year average of the ten-year security rate. Any one of these formulations would have given a rate higher than the current ten-year yield. Given the one point agenda of slashing the present rate of interest, what better way could there be than to forget weighted averages and just take a one-year rate. But that is not all. The committee now talks of a tax of ten per cent on PPF withdrawals even at maturity. Savers must beware. Is the committee talking of changing the scheme retrospectively, and will such a measure hold in law? One can understand a tax for early withdrawal but to put a tax on the maturity and that too with retrospective effect sounds like a blatant fiscal atrocity. One hopes that the government, in its wisdom, tosses out this recommendation. If at all a tax on withdrawals on maturity is to be introduced, it should only be on fresh accounts and not existing accounts.

The committee recommends that the Relief Bond should be discontinued. It has for years been argued that this is a costly instrument and the government should opt for higher nominal rates without fiscal privilege. But what the committee seems to veer round to is lower nominal rates without fiscal concessions. It is not clear whether the committee intends that the tax concessions on Relief Bonds be withdrawn during the tenure of the existing bonds. If this is
so, it would be grossly unfair.

The committee recommends withdrawal of the Sec 80L concession for small savings. Once again, the small savers are to be crushed at the altar of plutocrats who are, of course, to continue to enjoy tax-free dividends for unlimited amounts. There is more to come as the committee recommends a ten per cent tax deduction at source. Hapless small savers are expected to fill in the 15H form!

Let us say that the officials had to obediently carry out instructions. But what were the standard bearers of independent thought doing? Their integrity is beyond doubt but like Banquo in Shakespeare’s Macbeth they will moan “I must become a borrower of the night” — night associated with the evil of hurting the small saver. As for the chairman who has all along been an island of sanity in a world of monetary and fiscal madness, the dying small saver would cry “Et tu Reddy.”