The sharp lowering of interest rates on small savings may be considered a signal to the Reserve Bank of India to cut interest rates. If the RBI cuts interest rates, returns of debt funds will improve
Small savings are borrowings by the central government and therefore are absolutely safe. Time deposit rates and postal savings rates are not very different from the rates offered by commercial banks. For example, rates on deposits up to 2 years are lower than the State bank of India term deposit rates. Small savings rate is 7.1 per cent for 1 year, SBI is 7.5 per cent, while for 2 years small savings offers 7.2 per cent and SBI pays 7.75 per cent. For longer terms, the 3 years rate from small savings is 7.4 per cent and by SBI is 7.75 per cent and for 5 years small savings is 7.9 per cent and by SBI is 7.75 per cent. SBI is used as an illustration. There is not much to choose between banks and small savings and here banks will be more attractive considering their reach especially in urban centres and the range of services offered by them may lead customers to them, instead of post offices.
Other deposit schemes like Senior Citizen’s Savings Scheme (SCSS) remain attractive as the interest rate is down to 8.6 per cent, higher than the rate offered by banks. The SCSS is available only to individuals above the age of 60, or above 55 years if they have taken VRS and deposit their superannuation amount within one month of receipt. The 80C tax deduction on the SCSS is an added attraction. The quarterly interest payment makes this attractive to senior citizens. The maximum deposit amount is Rs 15 lakhs.
Postal savings account will continue to offer 4%, which is the lowest savings account rate mandated by the RBI.
Depending on the tax impact investors may opt for debt mutual funds, at least for the next few months, instead of bank or small savings term deposits. The sharp lowering of interest rates on small savings may be considered a signal to the Reserve Bank of India to cut interest rates. If the RBI cuts interest rates, the returns of debt funds will improve till the lower rates are factored into bond prices (there is an inverse relationship between interest rates and bond prices. As interest rates drop, bond prices appreciate).
Small savings schemes, barring the SCSS may not be attractive immediately, but if interest rates drop in the entire economy, which the bond market is expecting, the situation could change. Banks will reduce their fixed deposit rates on RBI action and the entire interest rate scenario would change.
Public Provident Fund, is a different sort of product. This is an excellent long term deposit and is ideally targeted for retirement. This 15-years plus account requires an annual deposit, with Rs1.5 lakhs being the maximum deposit per depositor per annum. The PPF is possibly India’s first floating rate investment. The rates on this have dropped from 12% at the turn of the century, to 8% and then increased to 8.7% (interim rates were 8.6% and 8.8%). PPF provides a sovereign guarantee making it absolutely safe. Investments enjoy 80C tax deduction, with interest and maturity proceeds also being tax free. The PPF continues to be attractive even at 8.1% and subscriptions to this will certainly not be impacted by the reduced rate.
The author is CEO & Founder, Right Horizons