Dipping into small savings funds to bridge fiscal deficit is costing Centre dearly

Even as the Centre took shelter under certain provisions of the FRBM Act and allowed itself the leeway to slip sharply on the fiscal deficit target, the Centre’s market borrowing figure oddly appeared sanguine.

Given the significant shortfall in tax and disinvestment revenues, the Centre revised its FY20 fiscal deficit to ₹7.66-lakh crore from ₹7-lakh crore in last year’s Budget. But the Centre did not increase its market borrowings to fund this additional gap in fiscal deficit.

Gross borrowings projection for FY20 that were pegged at ₹7.1-lakh crore in the previous Budget were retained.

The Centre has instead dipped into the pool of National Small Savings Fund (NSSF) to address the fiscal deficit.

Sharp revision

As against a budgeted ₹1.3-lakh crore, financing through small savings has been revised sharply to ₹2.4-lakh crore for this fiscal and the next.

While retaining the quantum of market borrowings reduces the risk of crowding out the private sector, the Centre’s increased reliance on NSSF comes at a high price, not only to the exchequer but also to the economy at large.

Over the past five years, financing through small savings funds has spiked — from ₹12,357 crore in FY14 to ₹2.4-lakh crore in FY20.

Given that small savings rates are kept high to ensure adequate flows into small savings, this increased funding of fiscal deficit through NSSF has come at a high cost. Interest payments by the government on small savings deposits and certificates (including operational expenses) has shot up to ₹59,581 crore in FY20 (revised estimates) from just ₹19,698 crore in FY14 — a three-fold jump.

Keeping rates high to attract flows into small savings schemes also impedes the transmission of rate cuts by the RBI, adding pressure on domestic interest rates.

Not market-linked

Interest rates on small savings schemes have always been kept attractive to ensure steady flow into these schemes.

For instance, from April 2012 until March 2016, the interest rates on small savings scheme were hardly tweaked despite two rate easing cycles. In a bid to align the rates on small savings schemes with market rates, effective April 2016, the Centre had decided to revise them every quarter based on the prevailing rates on G-Secs.

But, interest rates on small savings schemes have not moved in sync with the movement in G-Sec yields. For instance, in the whole of 2019, interest rates on small savings scheme were reduced only once (July-September 2019), by a mere 10 basis points.

The yield on 10-year government bonds, on the other hand, had fallen sharply by 80-90 bps during this period.

The higher interest rates on small savings schemes is in turn costing the Centre dearly. Its interest payment on small savings has gone up three-fold since FY14; the share of small savings interest payments in the government’s total interest obligation has gone up to about 10 per cent in FY20, from just 5 per cent in FY14.

The Budget has estimated the interest outgo on small savings at ₹72,934 crore for FY21, a 22 per cent jump from FY20.

Impeding transmission

If large government market borrowings lead to the crowding out of the private sector and hardening of G-Sec yields, and have a cascading effect on other financial market instruments, then the wide gap between interest rates offered on small savings and bank deposits, also leads to weaker transmission of the RBI’s rate cuts.

This is because banks are left with lower headroom to tinker with deposit rates and hence lending rates, if small savings schemes rates are kept high.

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