Small savings schemes: Move quickly and invest now

BL Research Bureau

Early next week, the Centre will announce the rates applicable on small savings schemes for the October to December 2019 quarter. There is a distinct possibility that the rates on these schemes may be cut. It makes sense for investors to move quickly and lock into high rates on these schemes now (see table). Small savings schemes include Senior Citizen’s Savings Scheme (SCSS), National Savings Certificate (NSC), Kisan Vikas Patra (KVP), Sukanya Samriddhi Yojana (SSY), Public Provident Fund(PPF) and post office deposits.

In the previous quarterly reset (July to September 2019) the rates on small savings schemes were cut by just 10 basis points (0.1 percentage point), despite expectations of a steeper cut. But investors may not be as lucky, going forward. The Centre may wield the knife more sharply this time around. Over the past few quarters, there has been a significant widening in the gap between the rates on small savings schemes and G-sec yields to which they are benchmarked. The Centre will likely seek to reduce the gap this time around.

Yawning gap

From April 2016, interest rates on small savings schemes are being reset on a quarterly basis. The idea is to align the rates on these schemes with those on government securities (G-Secs). So, as G-Sec rates move up or down, the rates on small savings schemes are also supposed to move every quarter. This mechanism is meant to blunt the edge of small savings schemes over bank deposits that were losing patronage due to lower rates.

But in practice, the quarterly reset mechanism is not always implemented properly, especially when G-Sec rates are on the decline. That’s because the Centre often seems reluctant to cut rates and upset investors in these schemes.

Consider this–the 10-year G-Sec rate rose for much of the last calendar year (2018) and went up to about 8.2 per cent in early October 2018. But then onwards it steadily declined, falling to a low of 6.3 per cent in July 2019; it is now about 6.8 per cent. So, in effect, compared with early October last year, the 10-year G-Sec yield is down about 1.4 percentage points. In contrast, on most small savings schemes, the rate has hardly changed - falling by just 0.1 percentage point.

In the reset for the October-December 2018 quarter, the rates on these schemes saw a spike of 30-40 basis points (0.3 - 0.4 percentage points). But then, for two quarters in a row (January to March 2019, and April to June 2019), the rates were left untouched – despite a significant decline in G-Sec rates. For the July to September 2019 quarter, the rates were cut by only 0.1 percentage point.

As a result, the rates on small savings schemes today are very attractive compared with many fixed income options. For instance, the interest rate on the Senior Citizen’s Savings Scheme (SCSS) is 8.6 per cent, the Sukanya Samriddhi Yojana (SSY) gets 8.4 per cent, while the Public Provident Fund (PPF) and the National Savings Certificate (NSC) both earn 7.9 per cent. Add the tax breaks available on these products and their effective returns are much higher.

Read | Govt may prune interest on small savings schemes

In theory, going by quarterly rate reset formula, the interest rate on small savings schemes should have been cut long ago - in the January to March 2019 quarter, in the April to June 2019 quarter or at least sharply in the July to September 2019 quarter. But Lok Sabha election considerations seem to have prevailed and held the Centre’s hand in the first half of the year. Also, the Centre may have been reluctant to cut rates sharply very soon after the government came back to power with a thumping majority, choosing instead to go with a nominal 0.1 percentage point cut for the July to September 2019 quarter.

Such largesse though may not continue in the upcoming October to December 2019 quarter. The RBI has been on a repo rate cutting spree this year in an attempt to boost growth in the economy. Despite last week’s big corporate rate tax cut which will add to the fiscal deficit, the RBI may continue with its repo rate cuts to give a leg-up to economic growth. This could reflect on the G-Sec yields and eventually on small savings schemes rates.

Even if the RBI does not cut repo rates further due to concerns about the fiscal deficit, the Centre may still choose to moderate rates on small savings schemes to make up for the pending cuts. The RBI and the Centre are on a drive to ensure faster monetary policy transmission in the economy. Banks have often complained that high rates on small savings schemes compel them to keep their deposit rates high to attract money from depositors. This, they say, also compels them to keep rates on loans high, thus impeding transmission of lower repo rates. In short, banks say that proper reset of rates (read, lower rates) on small savings schemes will enable better monetary transmission.

While the cut in small savings schemes rates need not necessarily match the decline in G-Sec yields over the past year, there is a good possibility that the rates will nevertheless head South. So, it makes sense to lock into high rates now, rather than wait and run the risk of settling for lower rates.

Go for fixed rate schemes

That said, invest quickly only in those schemes where it will help – that is, in fixed rate schemes where the rate at the start stays the same until maturity.

Small savings schemes can be variable rate or fixed rate products. The popular PPF and the girl-child oriented SSY are variable rate products in which rates applicable on the investment keep changing throughout the tenure. So, new rates announced for each quarter will apply to the accumulated corpus until then. Ergo: it will not really help to rush into investments in these schemes just to take advantage of higher rates now. The benefit will only until the end of this quarter, after which the new rates as per the next quarterly reset will apply on the accumulated investment.

Read | Small savings schemes will fetch lower returns

But in fixed rate products, the rate at the start of the investment stays until maturity. New rates announced each quarter will apply only to investments made in the quarter and will hold till their maturity. This category comprises the NSC, SCSS, Kisan Vikas Patra (KVP), post office monthly income scheme (POMIS) and post office time and recurring deposits. In the above fixed rate category schemes, it makes sense to lock into higher rates now for long tenures.

Safe and rewarding

Small savings schemes are offered by the post office, and also by some banks. They can fit in well in your fixed income portfolio. With government backing, these schemes are as safe as they get. Next, given their no-risk profile, the interest rates offered by many of these schemes are very attractive - higher than what most banks offer on their fixed deposits (about 6.5-7.5 per cent on 5-year deposits).

Read | A generation betrayed

Besides, many of these schemes enjoy tax breaks that pegs up their effective returns sharply. For instance, the PPF, NSC, SCSS, SSY and the 5-year time deposit are eligible for deduction under Section 80C up to a total of ₹1.5 lakh a year. Besides, the interest earned and maturity proceeds of PPF and SSY are exempt from tax, while interest earned on the NSC, if shown as reinvested, is also covered under Section 80C.

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