Staying away from the stock market because you're unable to cope with its wild swings? Well, debt options may now require close watching too, as their interest rates are likely to change from year to year. The government has recently announced changes which will make the small savings schemes administered by the post offices, market-linked. With this, crumbles the last bastion of ‘fixed' returns for retail investors. Though the modalities will be notified later, the move to reform small savings is based on the report of the Committee on the Comprehensive Review of the National Small Savings Fund. If the committee's recommendations are implemented in full, they will entail the following key changes to the post office schemes.

Floating rates with more liquidity

All post office schemes will be rationalised to fit into standard tenures ranging from 1 to 15 years. Towards this end, the National Savings Certificate (NSC) and the Post Office Monthly Income Scheme would be made 5-year schemes with a new 10-year NSC also to be introduced. The Kisan Vikas Patra will be discontinued. Interest rates on all the schemes (except savings deposits) will be linked to average yields on comparable government securities in the previous year.

Different products may offer mark-ups of 0.25 to 1 percentage point over and above the gilt yields to investors. Rates will be reset every year, in April, but will not change by more than 1 percentage point. All schemes (except NSC) will offer easier premature withdrawal, with a penalty clause.

Investor impact

What do these changes mean to you, as an investor? To start with, you will enjoy higher liquidity in post office products. It will also mean that you may receive higher interest from many of the schemes for the remaining months of 2011-12.

Interest rates on the 1 to 5 year time deposits are likely to be at 7.7 to 8.3 per cent this year, compared to 6.25 to 7.5 per cent currently. Interest rates on the five-year NSC and PPF (at 8.4 and 8.6 per cent) are higher than the current 8 per cent. However, before you rejoice over this unexpected largesse, you need to bear a few factors in mind.

If you have been used to predictable interest from your post office investments until now, that will no longer be the case.

Remember that the rates mentioned above are only for this fiscal, with new rates to be notified in April 2012. If interest rates have indeed reached the peak of their rising cycle, as many believe, next year's rates may not be the same. Then there is the question of the tax incidence on these schemes. The Gopinath committee has recommended doing away with the tax relief given to the accumulated interest on NSC certificates. The new Direct Tax Code, next year, may also propose changes to the tax structure of small savings. As of now, though the interest receipts on most small savings options are taxed, a few such as PPF remain exempt. Similarly, initial investments on schemes such as the PPF and NSC enjoy tax exemptions under Section 80C. Changes to any of these provisions will make a big difference to your effective returns.

Active management

All this also means more active monitoring of your debt portfolio. One can argue that once an investor locks into a post office scheme at the notified rate, he need not worry about market rates, as his investment will continue to enjoy fixed rates for the entire term.

However, problems arise because most retail savers do not make long-term investments at one go. If you are building a corpus towards retirement for instance, you are likely to build it through contributions made to the PPF, NSC or other instruments every year. Annual changes in rates will make it tricky for you to figure out exactly how much you will earn from your small savings portfolio at the end of say 5, 10 or 15 years. More churning will also be required by anyone looking to maximise debt returns. With returns on post office schemes likely to change annually, you may need to do some comparison shopping with bank deposits every time you have new money to invest.

And most important, even after all these tweaks, none of the fixed income options will deliver respectable inflation-adjusted returns. As beating inflation is the key objective of any long term investor, allocations to more risky options such as equities or real estate may now be unavoidable.

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