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Explained | Why the government can’t wait to cut interest rates on small savings

Hint: What a scheme pays out to subscribers as interest depends much on what the scheme earns.

April 02, 2021 / 08:14 PM IST
The decision on where the money is invested is not made by individual savings schemes but by the National Small Savings Fund (NSSF) into which deposits from the various schemes are credited. (Representative image)

The decision on where the money is invested is not made by individual savings schemes but by the National Small Savings Fund (NSSF) into which deposits from the various schemes are credited. (Representative image)

Interest rates on small savings schemes for the current quarter will be maintained at the levels of the previous quarter, the finance ministry clarified in an order issued late Thursday evening. That should bring to an end all speculations about a cut in interest rates after the conclusion of the ongoing Assembly elections in four states.

Rates can now be expected to be reset for the July-September quarter. The finance ministry had announced a massive cut in interest rates for the April-June 2021 quarter on March 31, through a mostly routine exercise, only to reverse it early the next morning amid angry protests from subscribers of the schemes and politicians.

The move will give some respite to savers who depend on these savings schemes for accumulating savings and earn incomes. However, as it happens with time deposits with banks, interest rates of small savings are reset from time to time.

The reset can happen as frequently as every quarter if the finance ministry decides so. However, the reset of rates has been limited to just once or twice a year since a decision for quarterly reset was adopted in January-March 2016.

What is the need for a rate reset?

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But why should interest rates on small saving schemes that were designed to provide a secure avenue for savings by middle and lower-income households, promote long-term savings and provide regular incomes be lowered drastically?

Quite simply, what a scheme pays out to subscribers as interest depends much on what the scheme earns. Typically, accumulations in small savings schemes are invested in government securities, and returns from these securities have been trending down for the past few years, just like interest rates set by the Monetary Policy Committee.

The decision on where the money is invested is not made by individual savings schemes but by the National Small Savings Fund (NSSF) into which deposits from the various schemes are credited.

The NSSF invests the accumulated deposits in the special government securities of the Centre and states. Special government of India securities offer a higher return than other government securities (G-Secs) of similar maturity.

ALSO READ: Interest rate cut U-turn: Should you continue with small savings schemes?

For instance, the coupon rate on 10-year special government of India securities issued to NSSF in 2017-18 was 8.4% while rates on 10-year G-Secs issued that year were 6.79-7.17%.

The interest rates are determined on these securities by the Union government. The special securities include the likes of oil bonds, food bond and fertiliser bonds at the Union government level. Since 2014-15, the NSSF has been investing in 10-year papers as against 25-year ones earlier.

According to a status paper on government debt for 2018-19 published last year, the NSSF had invested in Food Corporation of India, National Highways Authority of India, Air India, Indian Railway Finance Corporation, Power Finance Corporation and Rural Electrification Corporation.

The rate benchmark

Yet, the return on investments received by the NSSF does not determine interest rates on various small savings schemes. Interest rates payable on savings schemes are benchmarked to yields on government securities (G-Secs) of matching maturity.

Thus, the interest payable on the 15-year public provident fund is benchmarked to 10-years G-Sec and the 5-year senior citizens savings scheme is benchmarked to 5-year G-Sec and so on.

The NSSF also needs to earn enough returns on its investments to pay for the cost of management of the various small savings schemes and that includes commissions to agents who enrol subscribers and help with the collection of the subscription.

Government's small savings U-turn puts spotlight on calculation of interest rate

Any shortfall in the earnings of the NSSF to meet its payment liabilities and cover management costs has to be borne by the Union government. The Centre’s responsibility to ensure that the NSSF makes enough income has increased after 2014 when states started raising resources from the market for bridging their gross fiscal deficit instead of borrowing from NSSF.

States can raise money from the market at rates cheaper than those offered by NSSF. Only four states -Arunachal Pradesh, Delhi, Kerala and Madhya Pradesh - opted to continue borrowing from the NSSF. The status paper on government debt estimates that the share of NSSF in the public debt of state governments had reduced to 9.4% by March 2019 from 22% in March 2013. Correspondingly, the share of market debt climbed from 39.6% to 54.3%.

The budget estimates

Budget documents estimated the interest payment outgo in 2019-20 on small savings under the NSSF at Rs 1,11,381.66 crore. Total deposits accumulated in the small savings schemes at the end of that year was about Rs 23,48,268.68 crore, and that included Rs 8,46,660.74 crore of fresh deposits that year. An amount of Rs 5,66,385.81 crore was withdrawn during the year, leaving a closing balance of Rs 17,81,882.87 crore.

The budget documents have estimated that the interest outgo will rise more rapidly than the accumulations in the savings schemes between 2019-20 and 2021-22. It has estimated that the interest outgo will climb to Rs 1,57,603.48 crore by the end of the current fiscal year, up 41.5% from 2019-20. The accumulations in schemes will rise by 28.3% to Rs 30,12,624.76 crore and the closing balance by 36.5% higher to Rs 24,32,709.02 crore.

That partly explains why the government wants to implement a sharp cut in the interest rates offered on the small savings schemes even though it seems confident that earnings will be adequate to cover all the outgo during the year.

Lowering the interest outgo will allow the Centre to reduce the coupon rate on fresh issues of special securities, and thereby reduce the cost of borrowing for itself, states and public sector borrowers. Lowering interest rates on these schemes might work to slow the flow of savings into these schemes and thus reduce the pressure on the central government to borrow from NSSF.

Concurrently, it might encourage savers to opt for deposit schemes of banks, which would give banks access to cheaper funds and in turn keep lending rates benign.
Tina Edwin is a senior financial journalist based in New Delhi.

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