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Retail investing set for new profile

Suresh Krishnamurthy

BL Research Bureau

DIRECT investing in fixed income investment options received a rap on the knuckle from the Finance Minister as the administered rates on small savings schemes was reduced by 1.5 percentage points. Indeed, coupon rates on small savings schemes remained a high interest rate island despite two successive rate cuts in 1999 and 2000 and another 1 per cent rate cut was anticipated this year. However, the Minister has responded with a rate cut that was larger than the anticipated one percentage point cut. But this is lower than the two percentage points cut recommended by the Economic Advisory Council.

Importantly, the rate cut would place the yields on schemes such as Post Office Monthly Income Schemes and Kisan Vikas Patra at a level that is lower than the prevailing yield on Government securities with similar remaining maturities. On both these sche mes, there are no tax incentives such as rebates apart from the facility of no tax deduction at source and the deduction under Section 80-L.

In the case of the Post Office Monthly Income Schemes, the rate cut would also increase the attractiveness of regular income bond offers of ICICI and IDBI among others as things stand today. However, much would depend on the response of these financial i nstitutions to the rate cut. The same is the case with Kisan Vikas Patra. Rate cuts now make money multiplier bonds of the financial institutions attractive.

The changes in the Budget have considerably reduced the attractiveness of the National Savings Certificate as a tax saving investment option. Apart from the reduced coupon rates, the reduction in the deduction limit under section 80-L may lead to a much sharper fall in the effective post-tax yields for regular investors in NSC. However, for fresh investors, NSC may remain attractive on a relative basis.

In the case of PPF, despite the rate cut the schemes retains its sheen as a long-term investment option for people in the highest tax bracket. However, investors who sought to invest in the PPF for safety rather than tax rebates are likely to be quite ba dly hit.

Overall, the rate cut has the potential to bring about a material change in the investing habits of tax paying retail investors. In the backdrop of the declining yields on top quality corporate investment options, the rate cut is likely to make investing in mutual funds relatively more attractive. In the case of those planning for tax rebates, the three-year bonds of financial institutions and pension plans of mutual funds may now gain precedence over NSCs.

However, much would depend on the overall interest rate movement. If interest rates decline by a similar percentage, then considering the Government guarantee, small savings schemes and bank term deposits would continue to remain attractive. However, if interest rates on other investment options do not decline by a similar degree, then small savings may lose its sheen.