Small-savings rate cut: Home loans, EMIs will come down

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Updated: March 25, 2016 11:23:58 AM

If your risk profile is high, it's prudent to invest in equity mutual funds through SIP route, else, small saving scheme still offers the best long-term assured return investment option.

PPF, SMALL SAVING RATE CUTBanks have argued in the past that high interest rates on small-saving schemes has stopped them from cutting deposit and lending rates. With this rate cut, banks will be expected to cut both deposit and lending rate.

The government has cut small savings rate by 40-130 basis points and has linked it to Indian government bond rates and will be reviewed every quarter. Before this change, small saving rates were reset annually for the coming financial year. Now they will be reset on a quarterly basis and will vary in accordance with Indian Government bond yields.

Banks have argued in the past that high interest rates on small-saving schemes has stopped them from cutting deposit and lending rates. With this rate cut, banks will be expected to cut both deposit and lending rate.

This would further enable Reserve Bank of India, to cut the Repo rate, bringing down the rate structure in the economy. This opens us up to question about their impact on retail consumers and investors.

Small savings schemes are not as popular a financial instrument as they used to be in 1990s. Bank deposits have become much more important. Small savings used to be nearly 24 per cent of the overall bank deposits and their proportion has come down to just nearly 8 per cent of Bank deposits. This decline has accelerated since 2007. It is surprising given that there was nearly 150 bps spread between the small savings rate and deposit rates of banks.

Even after this rate cut, small savings continue to stay a very attractive low-risk, assured-return investment option for retail customers, and they still pay, on an average 60 bps above the bank deposit rate. Certain schemes such as PPF and Senior Citizen Scheme, pay as high as 110 bps (or 1.1 per cent) higher than the bank rate.

If a retail investor is looking to invest for a short period, which is 1-2 years, then bank deposits are a better option now as they pay marginally higher for same time period.

In a falling inflation and potentially a lower interest rate regime in near future, small savings rates might be revised downward further in the next few quarterly resets. Thus, we expect this to be a good time to save and invest the savings to lock returns in these small saving schemes by investing in longer tenure.

Falling interest regime will be beneficial from consumption perspective as retail loan rates, and home loan rate should fall further, reducing the EMI burden. These savings could be invested back in these schemes.

Mutual fund debt schemes will also benefit from falling interest rates and can be an attractive option but given that bond market was already expecting such cut, and hence had already priced the falling rates, we think that on tax and risk adjusted basis, it would still make sense to choose small-saving schemes.

Corporate Bonds are risky, particularly with the heightened leverage of corporate India’s balance sheet, and hence the risk is particularly high there. If your risk profile is higher, it’s prudent to invest in equity mutual funds through SIP route, else, small saving scheme still offers the best long-term assured return investment option.

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Puru Vashishtha is Board member, Deals4loans.com

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