Explained | Why do small savings rates matter so much, how do they affect banks and other questions answered

The government has left unchanged the interest rate for small savings schemes for the July-September 2021 quarter, a huge relief for small investors.

The Public Provident Fund (PPF) and National Savings Certificate (NSC) will continue to earn an annual interest of 7.1 percent and 6.8 percent, respectively, the government said on June 30.

The one-year term deposit scheme will yield 5.5 percent, while the Sukanya Samriddhi Yojana account will fetch 7.6 percent in the second quarter of FY22.

The coronavirus outbreak has led to job losses, businesses have suffered and families have seen their incomes shrink. The decision to hold the rates steady will be welcomed by fixed-income investors and there is a sizable number of them.

Why do small saving rates matter so much and how do they stack with those of commercial banks? Here are some answers:

How frequently are small savings rates reviewed?

Small savings rates are reviewed on a quarterly basis. In the April-June quarter, the government made an abortive attempt to lower the rates for these schemes amid a low interest-rate regime in the country. The cuts announced on March 31, 2021 were withdrawn the next day, ostensibly due to the ongoing assembly elections in five states.

Finance Minister Nirmala Sitharaman tweeted to say that the rate cuts were being withdrawn as the order had been issued “by oversight”. If the cuts had been implemented, the PPF rate would have fallen to 6.4 percent, its lowest since 1974. The NSC rate would have come down to 5.9 percent.

What does a change in rates mean for savers?

The ministry’s hasty reaction in the middle of an electoral exercise shows how important signalling around small savings rates is.

A large number of citizens invest their savings in these instruments which yield much higher income than bank deposits and are also backed by the sovereign.

For instance, a one-year term deposit with State Bank of India, the country’s largest lender, earns an annual interest of just 4.9 percent, as against the government-administered one-year deposit scheme’s 5.5 percent.

How do small savings rates affect banks?

The disconnect between small savings rates and bank deposit rates sometimes creates problems for the process of monetary transmission, or the trickling down of the Reserve Bank of India’s (RBI) repo rate cuts to the borrowers.

If small savings rates are high, commercial banks have to keep deposit rates competitive. This, in turn, affects their ability to price loans cheaply. When banks lend cheap and borrow dear, their margins come under pressure.

What is the current scenario on interest rates?

Since February 2019, the Reserve Bank of India’s monetary policy committee (MPC) has lowered the repo rate by 225 basis points to four percent to push economic growth. A basis point is one-hundredth of a percentage point.

In recent policy meetings, MPC has left rates unchanged on concerns around rising inflation. However, since growth is still under pressure, it has maintained an “accommodative stance”. The message to the system is to keep lending cheap, which also means that deposits turn cheap as well. But deposit rates are hard to cut when small savings schemes compete with them.

Where does RBI stand on small savings rates?

In the past, the central bank has made a case for aligning small savings rates more closely with the market.

In a paper dated November 12, 2001, a group of researchers from RBI said as the small saving schemes constituted a major segment of the financial sector, it was important to impart to them the necessary flexibility for healthy growth of the financial sector.

“The distortionary effects of administered interest rates and tax incentives on small saving schemes have often raised policy issues in the context of higher interest costs, fiscal burden, and implications for private investment,” the paper said.