Lower returns on small saving schemes! What are your options?

Juzer GabajiwalaVentura SecuritiesBefore investors could completely recover from the government of India’s Budget 2016 proposal with respect to EPFs, another adverse policy change concerning small saving schemes has stepped into the spotlight. One of the most popular small-saving schemes, PPF (public provident fund), will now fetch an interest of 8.1% as against 8.7% earlier.Interest rates on a range of small saving schemes, including Sukanya Samriddhi Yojana (SSY), National Savings Certificate (NSC) and Senior Citizen Savings Scheme (SCSS), have been cut by 40 to 130 basis points (see table below). These rates are effective from April 1, 2016 and will be subject to a quarterly revision based on a benchmark rate (10-year G-Sec yield).Snapshot of small saving schemes with the newly applicable interest rates (for April 1, 2016 to June 30, 2016)So, what does it means for an investor of popular small saving schemes like PPF and SCSS? Does it still make sense to continue to invest in them?Public Provident Fund (PPF): The popular Public Provident Fund (PPF) yields 8.1% from April 1, 2016 compared with 8.7% previous financial year. Despite the cut in rates, PPF still is a good bet as it has Exempt-Exempt-Exempt (EEE) tax status i.e. the principle invested, interest and maturity proceeds are all tax-exempt. Deposits into a PPF account qualify for tax deduction under Section 80C of the I-T Act. However, as the government is going to change PPF rates every quarter, based on the historical 10-year G-Sec yield, PPF rates can go further down as government bond yields are on a declining trend. Accordingly, what options or alternatives should you look at? Here is a couple:• Debt mutual funds offer scope for capital gains when rates fall. This is because bond prices are inversely proportionate to interest rates. One can expect returns in the range of 8-10% p.a. for a time horizon of 3 to 5 years.• Tax-free bonds are suitable for people who are in highest tax bracket of 30% and want to generate a stable income. These bonds also offer scope for capital gains when rates fall; this is not the case with PPF.Senior Citizens Savings Scheme: The impact of falling interest rates is felt most by retired people and senior citizens, who are dependent solely on fixed-income instruments. The interest rate on SCSS is down by 0.7 percentage points from 9.3% to 8.6%.If you calculate the impact of lower interest rates in terms of loss of earnings to the depositor, it is huge. For example, a person who has invested the maximum allowed amount of Rs 15 lakh in SCSS was earlier earning Rs 1,39,500 per year and will now earn Rs 1,29,000 per year. This translates into a drop of Rs. 10,500 (7.5%). So what options should senior citizen investors look at?Tax free bonds are a good option for individuals in the 30% tax bracket. As interest income from SCSS is taxable, the post tax returns on SCSS will be 5.94% for an individual in the 30% tax bracket whereas interest rates on tax free bonds are in the range of 7.00 to 7.25% for a time period of 10-15 years. One can also look at debt mutual funds as an option to SCSS. However, there will be no regular cash flows or income from this investment option. For an individual in the 10% tax bracket or lower, corporate fixed deposits (AAA rated) is a good alternative. The interest rate on Shriram Transport Finance’s Fixed Deposit is 9.25% p.a. for a time period of 3 to 5 years with regular income payouts.Other Small Saving Schemes: The interest rates on some other small saving schemes like Post Office deposits, Kisan Vikas Patra, etc. have been cut by 40 to 130 basis points. They are not very tax efficient instruments as interest is taxable and no deduction is available under sec 80C. Hence, investors who are investing in these schemes should look for better options like debt mutual funds and tax free bonds as explained above.Conclusion: Before making investment decision which involves fixed income instruments, consider the following parameters: 1. Do apple to apple comparisons by looking at post tax returns, i.e. take into consideration your income tax bracket.2. Your need for regular income or cash flows.3. Tax deduction under Sec 80C of I.T Act.4. Liquidity, i.e. investment tenure or lock in period before which the principal amount cannot be withdrawn.