Capitalmind
Capitalmind
Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
Economy

Budget 2016: Small Savings Schemes: Interest Rates Slashed!

In February this year, not even 3 weeks ago, the Finance Ministry announced some radical measures around the rates that various Small Savings Schemes currently offer. 

The products that are colloquially referred to as Small Savings Schemes include:

  • Post Office Savings Bank accounts
  • Public Provident Fund
  • Post Office Time Deposits (1-yr, 2-yr, 3-yr and 5-yr)
  • Post Office RDs
  • Kisan Vikas Patra
  • National Savings Certificate

among others.

Currently, the rates for these products stand at:

Small Savings - 2015

How Do the Interest Rates for these Schemes Get Determined?

The Ministry segregates these schemes, on the usage of the funds that are raised through them. Based on the perceived ‘nobility’ of the cause, the schemes offer rates above the benchmark Government Security of comparable maturities.

So for example, the Sukanya Samriddhi Yojana and the Senior Citizens Savings scheme offer 9.2% and 9.3% respectively; the highest among the Small Savings schemes. They enjoy a spread of 75 bps and 100 bps over the rate of G-securities of comparable maturities. This is what the Ministry had to say about the move:

  1. The Sukanya Samriddhi Yojana, the Senior Citizen Savings Scheme and the Monthly Income Scheme are savings schemes based on laudable social development or social security goals.  Hence, the interest rate and spread that these schemes enjoy over the G-sec rate of comparable maturity viz., of 75 bps, 100 bps and 25 bps respectively have been left untouched by the Government. 

  2. Similarly the spread of 25 bps that long term instruments, such as the 5 yr Term Deposit, 5 year National Saving Certificates and Public Provident Fund (PPF) currently enjoy over G-Sec of comparable maturity, have been left untouched as these schemes are particularly relevant to the self-employed professional and salaried classes.  This will encourage long term savings.

  3. The 25 bps spread that 1 yr., 2yr. and 3 yr. term deposits, KVPs and 5 yr Recurring Deposits have over comparable tenure Government securities, shall stand removed w.e.f. April 1, 2016 to make them closer in interest rates to the similar instruments of the banking sector.  This is expected to help the economy move to a lower overall interest rate regime eventually and thereby help all, particularly low-income and salaried classes.

All these revisions mentioned in the 3rd point above, will come into effect from April 01 this year. All revisions will be done each quarter.

Why is there so Much Clamor for this Move?

Why indeed? As per information from the RBI, at the end of May 2015 deposits under all the savings schemes put together, totaled Rs. 6.28 lakh cr. This included funds allocated towards Deposits, Certificates and the Public Provident Fund (PPF) schemes.

Small Savings - Schemes-01

Of these, the schemes that are going to offer rates more closely linked to the market are:

Small Savings - Schemes-02

All the figures are as of May 2015. As of that date, the funds under the schemes that are going to be affected by the revision of rates amount to Rs. 2.54 lakh cr – more than 40% of all funds invested in all these schemes!

The main reason why the Ministry is taking such a move, is to enable the easy transmission of rate cuts by the RBI, through to the consumers via banks. Banks are claiming that the attractiveness of these schemes, reduces the competitiveness of their interest-bearing products, as customers prefer to move to these smaller schemes where returns are higher. Apparently, the issue of the schemes’ higher interest rates having an impact on monetary transmission had been raised by the RBI with the government. Banks had also raised the issue at the pre-budget consultations held with finance minister Arun Jaitley.

There is another interesting tidbit in the FinMin announcement:

The compounding of interest which is biannual in the case of 10 yr National Saving Certificate (discontinued since 20-12-2015), 5 yr National Saving Certificate and Kisan Vikas Patra, shall be done on an annual basis from 1.4.16.

In effect, if the rates on these instruments were to go down by even 50 bps, that could lead to an annual savings of Rs. 1,250 cr. to the government. Coupled with the announcement of taxation on EPF funds, these are 2 steps that are sure to keep the country’s fiscal situation in check. We shall wait till the 15th of March, when the first revision gets announced.