Can anyone remember the last time financial papers went ecstatic about retaining tax sops for small savings? In just about two weeks, the Finance Minister (FM) will take a call on these, but very few would bother. It is amazing how fast the savings behaviour of India?s middle class has changed. This year, till December, the Public Provident Fund (PPF), a 15-year term investment vehicle, accumulated just Rs 837 crore. That is unbelievably low. This was the flagship savings scheme for every salaried Indian. Just two years ago, in 2005, PPF receipts by the end of December stood at an impressive Rs 7,000 crore, in line with the trend till then.
Sure, the government?s disposition towards the PPF did not go unnoticed, as the FM had appointed a committee to decide if such schemes should retain their tax-free status at the investment, accumulation and payout stages. Neverthelsss, savings behaviour has played a role. Also, the appointment of the committee should not have come as a shock. In four years, four panels?under Vijay Kelkar, Parthasarathi Shome, YV Reddy and Rakesh Mohan?had asked for a termination of the tax benefits. But governments have been afraid of the political consequences of acting on these recommendations.
Each committee saw these tax breaks as a handicap for the soon-to-be-launched market for pension plans. That market has sprung up now, with pension fund managers offering an ideal combination of debt and equity-based instruments as long-term savings vehicles. These do not offer PPF-like tax breaks, but are attractive all the same.
If the FM were to align the tax breaks on small savings with pension market products, few would demur. Yet, it is a fair assessment that the Indian middle class is just not attracted by tax breaks anymore when it comes to savings. Credit the stockmarket boom for this. Like in any mature market economy, notions of savings, and therefore investment, are being reshaped by increasing awareness of returns from the active markets for capital, real estate and even commodities in India. The latest NCAER-Max New York Life survey on savings and investment patterns shows that more than 50% of the small savings of households, once in schemes, have migrated to bank deposits. These are national figures, and that means this has happened even in small towns, where small savings used to have their largest draw.
The close cousin of PPF, the post office monthly income accounts, has met a similar fate. This fiscal, the government had restored their ?bonus? to boost their attraction. Yet, there has been a net decrease of Rs 10,587 crore in all government savings deposits and certificate schemes. The government?s estimated collection from this source was Rs 41,110 crore for the year.
If one wants more proof that tax breaks do not steer Indian savings behaviour any more, one only has to look at receipts of the tax-free bonds floated by National Highways Authority of India. Capital gains made from the interest income on the bonds are exempt from tax under section 54EC of the Income Tax Act. Sure, the finance ministry has imposed a cap of Rs 50 lakh for every applicant. But even then, till the end of December 2007, the total receipts from these bonds were less than Rs 100 crore, against a target of Rs 2,000 crore.
All this indicates a striking break in the Indian economy?s savings pattern. In fact, as the Central Statistical Organisation?s quick estimate data for 2006-07 shows, the economy has logged a savings rate of 34.8%. The difference with the domestic investment rate is less than 50 basis points. This means the FM can safely go ahead with the project of developing an Indian market for pension schemes without being fazed by the clamour for tax breaks to sustain the savings momentum of the economy. His two worries?of a potential backlash and a possible dip in the savings rate?are well taken care of. Why should the government hand out more sops?