Interest rates set to head south again

New Delhi, February 3: | Updated: Feb 4 2002, 05:30am hrs
Led by the small savings the downward journey of interest rates is set to continue in the forthcoming Budget. Though it is almost certain that the Budget will change the administration of the small savings schemes, the extent of interest rate cuts and removal of tax benefits on them are likely to be decided more by political considerations like adverse public reactions than economic logic.

Finance minister Yashwant Sinha had effected a 1.5 per cent reduction in the administered interest rates in the current budget and also said he would explore the possibility of unveiling a better administrative system for managing these rates. Following this, interest rates on provident fund and other schemes came down from 11 per cent to 9.5 per cent. However, this is still higher than the average yield on the government securities.

North Block sources, however, pointed out that the recommendations of the committee headed by RBI deputy governor YV Reddy on administered interest rates was likely to be adopted as the the base model for administration of small savings and provident funds in the coming years. They also said the ultimate objective of establishing a rational interest rate regime and removal of tax sops were to give the small investors a choice between the fixed and floating rates at the time of their entry. However, provident funds (PPF, GPF and EPF) were expected to remain out of this proposed option, they added.

The Reddy panel has recommended that the interest rate on small savings be benchmarked to the return on government securities of the similar maturity periods. Interest rates on PPF could be benchmarked to average the secondary market yield on government securities having a residual maturity of around 10 years, the report said, adding the interest rates on other administered schemes like GPF and EPF might follow the principle applicable to PPF.

The committee has also said the spread over the benchmark yields for fixing the interest rates on the small saving schemes might have to be suitably calibrated, subject to a maximum of 50 basis points, depending on the maturity and liquidity of the instrument. This should be done keeping in view of the interest of the savers, particularly for long-term instruments.

The committee has further observed that the present system of direct management of the long-term funds by the public sector and fixing of administered interest rates with all tax advantages would not be sustainable in the medium-term, as most of these funds, in future, were expected to be privately managed with larger and diversified investment portfolios. u

The medium-term objective of the government should be to spell out a well-conceived investment policy to facilitate switching over to fully-funded long-term saving schemes managed independently and professionally and aimed at promoting growth, besides meeting genuine investment demands in the economy, the report said.