Editorial: Small savings, big problem

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Published: January 15, 2016 12:13:20 AM

Rate cut will help banks lower interest, but not much

The government, news reports suggest, will soon be cutting rates on a host of small savings products through a combination of looking at their spreads—over government securities of a similar tenure—as well as by setting interest rates every quarter instead of the current practice of doing this once a year. Just doing this, based on G-Sec rates in the last quarter, can reduce interest rates on small savings by upwards of 50 bps—if the spreads are reduced from the current 25 bps for all products, the rates can be cut even more. Theoretically, this means banks, that have not been able to cut deposit, and hence lending, rates due to high interest rates on small savings schemes, will now be in a position to do so. The problem, however, is that all indications are the government is not going to do this for schemes of 5 years and more, or for schemes for either women or senior citizens —this means interests on the popular NSCs and PPF will remain untouched. The argument being given is that since the bulk of retail bank deposits—over 70%—fall in the 1-3 year bucket, the government will fix the problem that banks face while, at the same time, preserve enough of an incentive for savers

What the government is planning is welcome, but far from enough. For one, the tax savings on all small savings schemes, along with their higher interest rates—even after they are cut—makes them far more attractive than bank deposits since, at even a 10% tax rate, their effective interest reduces by a tenth. In the case of a 1-year deposit, SBI gives a 7% rate which effectively becomes 6.3% post-tax as compared to 8.4% on a 1-year small savings scheme right now, and will reduce to, possibly 7.9-8% after the quarterly reset policy is brought into force. Two, leaving out longer-tenure schemes like NSC and PPF, where the effective interest differential will now become much higher, will mean more money will flow into them—roughly a fourth of all small savings take place in these schemes even today. Apart from the impact this has on the banks’ ability to attract deposits, it is not clear that higher interest rates are what drive savings anyway—it is really incomes that determine how much gets saved, while interest rates determine what instrument the savings should be channelised into. Since the G-Sec rate, in any case, offers a reasonably high spread over CPI inflation, the government would do well—in even the small savings of under-5-year tenure if it doesn’t want to do it across the board—to cut the spread by more than the current 25 bps; it is an even higher 50 bps for NSCs and 100 bps for schemes like those for senior citizens. At the end of the day, the government needs to keep in mind that, with WPI in the negative territory, firms are seeing interest costs of 12-14% which, for all practical purposes, make investment a bad idea. If investments don’t grow, nor will the economy, and even the higher rates of interest offered on 5-year tenure schemes will not be enough to attract more investors.

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