Now’s the time for small savings schemes

Safe and rewarding – small savings schemes offered by the post office and some banks can make for a neat fit in your fixed-income portfolio.

With government backing, these schemes are as safe as they get. Next, given their no-risk profile, the interest rates offered by many of these schemes are very attractive — higher than what most banks offer on their fixed deposits. Besides, many of these schemes enjoy tax breaks, pegging up their effective returns sharply.

For instance, the Public Provident Fund (PPF), the National Savings Certificate (NSC), the Senior Citizen Savings Scheme (SCSS), the Sukanya Samriddhi Yojana (SSY) and the five-year Post Office Time Deposit are eligible for deduction of up to ₹1.5 lakh a year under Section 80C.

Besides, the interest earned and the maturity proceeds of PPF and SSY are exempt from tax, while the interest earned on NSC, if shown as reinvested, is also covered under Section 80C.

While you can invest in small savings schemes any time of the year, it seems a particularly opportune time now to deploy money in these instruments. That’s because interest rates on these schemes are ruling high and could possibly decline in the coming quarters.

Pending cuts?

From April 2016, interest rates on small savings schemes have been reset on a quarterly basis.

The idea is to align the rates on these schemes with those on government securities (G-Secs).

So, as G-Sec rates move up or down, the rates on small savings schemes are also supposed to move accordingly every quarter.

This mechanism was meant to blunt the edge of small savings schemes over bank deposits that were losing patronage due to lower rates.

But, in practice, the quarterly reset mechanism is not always implemented, especially when G-Sec rates are on the decline.

That’s because the Centre seems reluctant to reduce rates and upset investors in these schemes, more so in the heated election seasons.

Consider this. The 10-year G-Sec rate rose for much of the last calendar year and went up to about 8.2 per cent in early October 2018.

But then onwards, it steadily declined, and is now at about 7.4 per cent. In the reset for the October-December 2018 quarter, the rates on small savings schemes saw a spike of 30-40 basis points (0.3-0.4 percentage points).

But then, for two quarters in a row (January-March 2019, and the recent April-June 2019), the rates on most small savings schemes have been left untouched, despite a significant decline in G-Sec rates.

As a result, the rates on small savings schemes today are very attractive compared with many other fixed-income options. For instance, the interest rate on SCSS is 8.7 per cent, SSY gets 8.5 per cent, while PPF and NSC both earn 8 per cent. Add the tax breaks, and the effective returns are much higher.

In theory, going by the quarterly rate-reset formula, the interest rate on small savings schemes should have been cut in the January-March 2019 quarter, or at least in the April-June 2019 quarter.

But election considerations seem to have prevailed and held the Centre’s hand. The largesse though may not continue in the upcoming July-September 2019 quarter, by when the election dust would likely have settled.

Besides, going by its recent statements, the RBI may continue with its policy rate cuts, which could also reflect on the G-Sec rates and eventually on the rates on small savings schemes.

Even if the RBI does not cut rates further due to concerns that inflation may rise with higher food and fuel prices, the Centre may still choose to moderate the rates on small savings schemes to make up for the pending cuts.

While the cut in rates need not necessarily match the decline in G-Sec rates, there is a good possibility that the rates on small savings schemes will head South.

So, it makes sense to lock into high rates now, rather than wait and run the risk of settling for lower rates.

Go for fixed-rate schemes

That said, make haste only in those schemes where it will help — that is, in fixed-rate schemes where the rate at the start stays the same until maturity.

Small savings schemes can be variable- or fixed-rate products. The popular PPF and the girl child-oriented SSY are variable-rate products in which rates applicable on the investment keep changing throughout the tenure.

So, new rates announced for each quarter will apply to the accumulated corpus until then. Ergo: it will not really help to rush into investments in these schemes just to take advantage of higher rates now. The benefit will only be for a quarter, after which the new rates as per the next quarterly reset will apply on the accumulated investment.

But in fixed-rate products, the rate at the start of the investment stays until maturity. New rates announced each quarter will apply only to investments made in the quarter, and will hold till their maturity.

This category comprises NSC, SCSS, Kisan Vikas Patra (KVP), Post Office Monthly Income Scheme (POMIS) and Post office time and recurring deposits. In the above fixed-rate schemes, it makes sense to lock into higher rates now for long tenures.