Pulling down the interest rates on deposits into small savings schemes was one of the reasons why Yashwant Sinha became a vastly unpopular finance minister in 2002. But what?s changed since is that retail investors have themselves left the small savings window for better options as the economy has matured. From over R1 lakh crore, the annual accrual has dipped to a quarter in 2011-12 in such small savings. In that context, last week?s decision to carry through the reforms suggested by the Shyamala Gopinath committee on small savings is welcome, though hardly brave. The principal beneficiary of the changes will be the state governments cutting their interest liabilities. The effective rate of interest at which states were borrowing from the fund was almost 10%, while the rate at which the Centre borrows from the fund has declined to below 8.5%. Moreover, when market rates (read bank deposits) dip, inflows into the fund rise as retail investors prefer the higher rates of these savings. Since states, as per FRBM, are locked into a borrowing limit, they are forced to accept the high-cost deposits, before they can opt for open market borrowings.
The decision to calibrate the rates on small savings with government securities will finally remove this anomaly. The concurrent reduction in the amount states need to pick up from the fund to 50% of the corpus opens the route for larger market borrowing. For the banks, too, the calibration makes it possible to offer deposit rates that move at par with market interest rates. While the anomaly of a government-run small savings scheme in a sophisticated financial market will persist, the elimination of outmoded agency incentives on all these schemes will cut the impact. When the banks are spreading out into the rural areas, any challenge to them must come from non-state actors rather than a government-run scheme. Eliminating Kisan Vikas Patra, increasing the rate of interest on PPF and introducing a 10-year paper is the other leg of the reform that aligns the small savings window with a long-term savings plan. This was possibly also a good time to do away with the tax exempt status of the PPF, to bring it in line with comparable insurance and pension products. Pranab Mukherjee would not have lost his job if this had been done.