When the government, in March last year, announced the plan to reset interest rates on small savings every quarter, most thought it would usher in an era of low interest rates, in keeping with the falling rates on government securities (G-Secs). As the government press release put it, the move “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”. If rates on small savings were to come down—the tax breaks on many make them even more attractive—banks would be in a position to lower deposit rates and, therefore, lending rates. The problem, however, is that despite the announcement—even spreads over G-Secs were announced like, for instance, 75 bps for the Sukanya Samriddhi Yojana and 100 bps for Senior Citizen Savings Scheme—rates have not come down commensurately. Which is why, in February, RBI said interest rates would come down faster if rates on small savings came down—these rates, the central bank said, “are about 65-100 basis points higher … compared to what they should be if the formula is followed”.
So while the government has cut rates on small savings by 10 bps for the second successive quarter, the interest rate on the tax-free Public Provident Fund (PPF) has been set at 7.8% for July-September—after factoring in the 25 bps spread that was announced for this product, the rate should have been around 7%; an 85 bps extra return, apart from generous tax incentives makes the PPF far superior to anything a bank can offer. While SBI offers 6.25% on a five-year deposit, the same scheme in a post office fetches 7.6%, a full 55 bps higher than it should be based on the formula announced by the government—a five-year NSC offers an even higher 7.8% interest rate which is 75 bps more than what the formula warranted.
At a time when inflation was high, the government wanting to protect those investing in small savings rates still made sense. Today, however, inflation levels are at almost historical lows, making the real return much higher than in the past. With CPI at 2.18% right now, the five-year NSC has a real return of 5.6% and the Sukanya Samriddhi Yojana offers 6.1%. Apart from the fact that not cutting rates enough is hindering monetary transmission, from the point of efficiency, the government must adhere to its own set rules and bring in parity in returns of all financial products of similar risks.