The Hindu Business Line : High-cost of small savings fund loans: States feeling the pinch

STATE governments now reel under the relentless impact of the expensive loans they have contracted from the National Small Savings Fund (NSSF) in view of the latter's adverse fallout on the state debt with its high cost operation, even as the states had popularised the small saving schemes over the years.

Highly placed sources in the Government told Business Line that after the Twelfth Finance Commission (TFC) made its recommendations, the Finance Ministry decided to give only the grant component of Central assistance for State Plans in 2005-06, besides modifying other procedures affecting transfers to states.

Currently, the NSSF remains the principal source of Plan loans for many states and might soon hold a disproportionate share of the state's debt servicing burden as lending rates from this source is, by far, several percentage points above the coupon rate for state paper. This also reflects the fact that the interest rate on these savings is fixed administratively by the Central Government and the cost of administering the scheme is also exorbitant.

The sources said that as the Ministry of Finance in the budget estimates assumed Rs 90,000 crore of net small savings for this fiscal, the actual releases of small savings loans made to states in the first quarter of the current year already entailed substantial sum. If the present trend persists, the full year's receipts could end up far more than the Finance Ministry's projections.

This is despite the fact that the Finance Ministry has restricted investment in small savings to individuals alone from May 13, 2005, and institutions could no longer invest. This provision has been extended to trusts and provident funds in a bid to stem the high interest payout on this score. Paradoxically, state governments appear to be flush with funds, mainly due to the automatic credit of small savings raised in their jurisdiction to their accounts as loans by the Finance Ministry at a higher cost, the sources said.

However, this is fraught with risks for the finances of states. One, small savings loans at 9.5 per cent interest swell their governments' debt servicing liabilities, when they can raise market borrowing at 7.5-8 per cent today. If small savings loans are treated as inevitable, obligatory borrowing for states loans, indicated in their scheme of Plan funding from banks and financial institutions (negotiated loans), might not be permitted by Finance Ministry. As negotiated loans are project-linked and, most often, incurred by agencies outside government, the sources contend that if they are substituted by NSSF loans, borrowings will have to pass through State budgets.

States are aggrieved that though the Finance Minister had hinted at his meeting with the Deputy Chairman of the Plan panel that he would allow NSSF loans to be used for prepayment of high-cost loans taken by states from financial institutions, instructions to this effect have not been followed up.

There are also fears that the escalating trends of borrowed NSSF resources could have perverse incentives in the form of discouraging revenue-raising bids of state governments which would likely to take the fizz out of tax reform, user charges for public services and expenditure management drive. All these would "negate and nullify the benefits accrued to the states following the fiscal prudent path laid out during the last five years and put them back on the debt precipice", fiscal experts warned.

Even as several state governments have withdrawn all measures promoting small savings certificates for users of major government services, they find it difficult to reduce commissions being doled out to agents for promoting small savings, since it forms a significant chunk of steady income to poor individuals and self-help groups of micro finance bodies.

Considering the fact that how the Monthly Income Scheme is being touted as specially suited for retired employees/senior citizens or anyone with high sum for investment by dangling the rate of interest of 8 per cent, 10 per cent bonus on maturity with a maximum limit of Rs 6 lakh for joint account, the need for ironing out the mismatch between the interest rate differential in the NSS and bank deposit comes to the fore if the intention of the Government on its fiscal prudence objectives are not to be defeated. States also must be discouraged from promoting NSS schemes and the attendant costly burden such NSS loans cast on them, the sources said.

The Mid-Term Appraisal of the Tenth Plan pertinently said that though small savings are now off the Central budget, the Centre's ability to fix lending terms and its growing importance as a source of finance for State Plans makes this a potentially disruptive issue in Centre-State financial relations which need to be tackled head-on. Otherwise, cooperative federalism as a bulwark in Centre-State fiscal relations would get shaken, the sources added.

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