Sticky rates

| Updated on March 09, 2018 Published on April 23, 2017

If the Government wishes to subsidise small savings schemes, it must do so efficiently and transparently

After urging the Reserve Bank of India and banks to slash their interest rates to rejuvenate the economy for the last three years, the Government seems to be having trouble sticking to its own prescription. The Centre has just announced an 8.65 per cent interest rate for the Employees Provident Fund (EPF) for FY17, just a 15-basis-point reduction over last year. And after announcing a new formula to recalibrate interest rates on its post office schemes to align with the market, in the past year the Centre has been loath to peg down these rates in line with market trends. After four rounds of quarterly revisions, interest rates on post office schemes such as five-year time deposits, NSC, Public Provident Fund (PPF) and Senior Citizens Savings Scheme (SCSS) are lower by just 20 basis points compared to last year. But in the past year, the RBI has slashed its repo rate by 50 basis points, the ten-year gilt has seen a 50-basis point yield decline, and banks have effected a 50 to 70 basis points cut in term deposit rates.

Yes, there are both costs and benefits to the Centre ensuring that some savings schemes remain islands of high returns. On the plus side, post office schemes and the EPF serve as instruments of social security. Over the years, a shrinking menu of government-backed debt instruments and the withdrawal of tax benefits on debt returns have left sections of savers vulnerable — such as senior citizens, pensioners, low-income earners and the self-employed — bereft of any savings avenues that offer a consistent real return. Thus it may not be amiss for the Government to transparently subsidise such vehicles. But on the flip side, the sticky rates do impede monetary transmission. With small savings rates now at a stiff premium to bank deposits, banks are bound to cry foul that they will cannibalise deposits. Given that the EPF and post office schemes are sovereign guaranteed, the Centre will also have to foot the bill for any shortfall in the actual returns earned by these vehicles. With the EPF, with equity investments bolstering returns, this may not be an issue this year. But as the small savings mop-up is used by the Centre in place of market borrowings, higher rates will inevitably peg up its interest outgo. This will call for limiting the inflows.

The Government can manage this tightrope walk by ensuring that sovereign-backed schemes that offer subsidised returns are finely targeted at the most deserving sections of the population. Presently, this is achieved through blunt instruments. The EPF is voluntary for workers earning over ₹15,000 a month. There are monetary caps on the sums individuals can invest in schemes such as the PPF and SCSS. But with more precise verification devices such as the Aadhaar now available, it should be possible for the Government to more scientifically target the subsidy, so that sticky interest rates don’t morph into much-criticised ‘bounties’ for the rich.

Published on April 23, 2017
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