Aarati Krishnan

Squeezing the small saver

AARATI KRISHNAN | Updated on January 19, 2018 Published on February 12, 2016

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It is illogical to force retail savers to take on market risks, while domestic institutions stick to the safety of guaranteed returns

With the Centre deciding to reset the interest rates on post office schemes every quarter (instead of every year), one of the last bastions of predictable returns available to the Indian saver will soon fall. This is unfortunate.

Policymakers and commentators in India talk quite a lot about the need to channel long-term retail savings into financial instruments. They freely criticise the retail investor’s lack of a long-term ‘mindset’. ‘When retail investors can lock into property or gold for 15 to 20 years at a time, why can’t they do the same with bonds or equities?’ they ask.

But the explanation is quite simple. Small savers looking to park their long-term surpluses have hardly any suitable options left.

Two’s better than ten

This may seem like an alarmist statement, until you actually take stock of the menu for an individual looking to park 10- or 15-year money.

For a start, all savers need a bedrock of fixed income investments on which to build their portfolios. So what are the 10-year-plus debt options available?

One, there are the term deposits from banks where one can lock into prevailing interest rates for 1 to 10 years. But a 10-year term deposit with the country’s largest bank — SBI offers an interest rate of 7.25 per cent. This is a good 50 basis points lower than the 7.75 per cent available on its two and three-year deposits.

In fact, all Indian banks actively discourage investors from parking 10-year money with them. Banks are signalling to savers that if they want to lock into any long-term deposit, they will need to take a haircut on returns. That’s because with domestic rates moving dramatically up and down every three or five years, banks are wary of taking any rate risk (uncertainty about falling interest rates) on their books.

Shrinking menu

Two, there are the small savings schemes, but locking into a certain return for the long-term has become next-to-impossible with these schemes too.

For one, the basket of post office schemes that allow the investor to park 10 or 15 year money has shrunk dramatically in recent years. The sole small savings scheme that today accepts long-term money is the Public Provident Fund (15 year maturity). And the PPF doesn’t really shield savers from rate volatility, as the interest earned on its balances is subject to yearly resets (this will soon be quarterly).

With the discontinuation of the 10-year National Savings Certificates, savers have just one other option — the Sukanya Samriddhi Scheme (it can be held until the child is 18). However, this is open only to those fortunate enough to have a girl child.

Most small savings schemes (except for the Senior Citizens Savings Scheme and the Kisan Vikas Patra) now pass on rate risk to the investor, as their interest rates are pegged to gilt yields and reset annually. Note that even the Senior Citizen’s Savings Scheme, which is supposed to help the retired meet their monthly living expenses, accepts money only for five years at a time!

A third set of long-term debt options that are available to the retail investor are the tax-free bonds from the public sector which offer fixed rates for 10, 15 or 20 years.

But if you’re a small investor, getting your hands on these fancied bonds is a Herculean task. These bonds are notified in each Budget and open only for brief windows of time. When they do, they are also bunched up and everyone from insurance companies to high net worth investors scramble to invest in them.

Under the circumstances, a retail investor has to have either won a lottery (so that he has bagfuls of money to bid) or be ultra-savvy (he needs to apply within an hour of the offer opening) to bag allotments. Investors need to be clued on to bond market moves too, as their interest rates closely track gilt yields.

Why not equities?

But why should a retail investor stash his long-term money in fixed income instruments at all, when he has equities — that assured generator of long-term wealth? Well, no matter how much you believe in their long-term potential, equities cannot be everyone’s of cup of tea.

For one, there have been prolonged phases in India where equities have delivered sub-par returns (the Sensex return in the last 10 years is under 9 per cent).

Two, as any professional financial adviser will tell you, hardly anyone can live with a 100 per cent equity portfolio. To construct a sound long-term portfolio, it is essential to have a basic allocation to fixed income — over which you layer equities, property and gold. Think of a daily wage-earner, farmer or a senior citizen who earns just about enough to meet his living expenses. He certainly cannot allocate much to equities, as he can afford to take zero risk to his capital.

Given that the majority of the Indian population is still stuck in the low-income bracket, expecting all retail savers to bet on equities if they want to be ‘long term’, reminds one of a certain French queen asking indigent peasants to eat cake.

Market forces

Purists will argue that the vanishing breed of ‘fixed return’ options is the inevitable consequence of market forces. With the Indian economy making a rapid transition from a regulated economy to one that is open to global influences, no one, they will say, can escape market risks.

Well, those purists need to explain why domestic institutional investors get to avoid those very same market risks. Today, while small savers in India are asked to take on risk either through rate cycles or equities, domestic institutional investors still get to lock safely into government guaranteed returns for 20 to 30 years at a time.

Don’t Indian banks, insurance companies and pension funds all park the bulk of their surpluses in the safest instrument of all – Government of India securities? For long, Indian banks have preferred to park money in excess of their statutory requirements in g-secs. Insurance companies have been the most ardent subscribers to 10 to 30 year g-sec auctions and buy-and-hold them to maturity. And we all know how many years it has taken for the Government to coax the Employees Provident Fund Organisation to dip its toes into equities.

The real irony is that, retail investors wishing to have some predictability to their returns are now forced to hand over their money to these institutions (via traditional insurance plans or PF, for instance) and suffer their high costs or other inefficiencies, in order to ‘reap the benefit’ of assured returns.

If the Centre is really keen to see small savers in long-term instruments, it should remedy this anomalous situation. It is time to facilitate easier access for retail investors in 10, 20 and 30 year g-sec auctions. More public sector institutions like the Indian Railways should be nudged to tap retail investors, for long-term money.

At the same time, institutional investors also need to be pushed towards market-linked instruments. After all, they should have far better skill sets than small savers to take long-term calls on interest rates, and hedge against market risks using derivative instruments.

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Published on February 12, 2016
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