Island of high rates

| Updated on January 23, 2018 Published on April 09, 2015

Higher interest rates on small savings could lead to challenges for banks and for the government borrowing programme

It is somewhat ironic that the Centre, which has been demanding that the Reserve Bank of India and commercial banks swiftly slash their interest rates to stimulate the economy, has taken a diametrically opposite stance on small savings schemes. With effect from April 1, the date on which small savings interest rates are reset each year, the Centre has pegged up the rates offered on the Sukanya Samriddhi Scheme and the Senior Citizen’s Savings Scheme by 10 basis points while maintaining rates on all other products. The idea is to attract more household savings into financial products, but the island of high returns in post office schemes after this move may create challenges for banks as well as the government.

Given the extensive reach of the post office network, small savings schemes compete directly with banks in the race to garner household savings. Trends in bank deposit vis-à-vis small savings collections clearly demonstrate that Indian savers actively switch between the two avenues on the basis of interest rates. Therefore, as long as post office deposits continue to offer rates of 8.4 to 8.5 per cent for one to five-year term deposits, it is hard to see how banks can go ahead and sharply trim their deposit rates and effectively transmit RBI policy actions to their borrowers. At current interest rates, small savings schemes are an expensive mode of borrowing for the exchequer. The lion’s share of the corpus of the National Small Savings Fund (where collections are housed) is lent out to the Centre or States at interest rates of over 9 per cent. Yet, after the sharp rate declines of last year, the government can today borrow 10-year money from the market at 7.8 per cent. The NSSF faces a problem of long-term viability too, with receipts routinely falling short of expenses by ₹15,000 to ₹20,000 crore a year. With its corpus of ₹9 lakh crore and implicit sovereign guarantee, this should be a source of worry for the Centre. It was to address precisely these issues that rates on post office schemes were transitioned to a g-sec based formula three years ago, on the recommendations of the Shyamala Gopinath Committee. The Committee had suggested adhering to a 25 basis point spread for all schemes (except two) over comparable g-sec yields. Given that rates on some schemes have been hiked this year and some not, it is unclear if this formula is being applied.

If the Centre plans to rely heavily on small savings to mobilise household savings, it needs to hunt for higher yielding investments for the NSSF — a difficult task when market rates are headed south. It also needs to clearly delineate the end-use of NSSF borrowings. It would be a pity if, after attracting small savers in large numbers to post offices schemes with high rates, the funds are frittered away in unproductive operational expenses.

Published on April 09, 2015
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