Was it April fool’s joke on small savers?

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Close-up Of A Businesswoman's Hand Stopping The Wooden Blocks From Falling On Stacked Coins

By DM Deshpande

Late in the evening on March 31, the government announced steep cuts in interest rates on small savings; only to be reversed by the finance minister within 24 hours on the next day.

The official explanation given was that the rate cut announcement was done through an ‘oversight’. It is not difficult to see why the faux pas had to be attended to on an emergency basis.

The nation is in the middle of elections to five crucial states and a decision so important as to cut rates substantially would not have gone well with a large section of voters! Add to that the woes caused by rising COVID caseload numbers leading to loss of lives and livelihoods and rising inflation, the government obviously committed a harakiri. Fortunately, in damage control mode, it acted swiftly to restore the status quo.

Nevertheless a cut in small savings rate would have been in line with the overall fall in interest rates including those of the bank deposits. The decision to reset rates on small savings has always had political overtones in India. Generally, they have remained at levels higher than the comparable levels of other financial instruments. The RBI and the top economists have lamented that due to this the monetary transmission has remained incomplete. It has also resulted in distorted interest structure in the country.

At times bank deposits have migrated en mass to small savings in search of higher and safer returns. Banks and financial institutions have not been able to cut lending rates due to the prevalence of high rates on small savings. In recession and a time like this where the country is hit by the pandemic, lower rates would encourage borrowing
and consumption.

It would typically leave more money in the hands of firms and individuals. This would lead to faster recovery and growth of the economy. Corporate credit growth has been sluggish; as of February 2021, it has contracted by 0.24 per cent. There are other important reasons why companies are not borrowing and investing besides the interest factor.

For instance, the demand has not been picking up; there are fears of lockdowns in states that are badly hit by the second wave of the pandemic. The retail lending too has not picked up momentum staying in single digits after disastrous previous year.

The third beneficiary, in fact the biggest, after firms and individuals is the government itself. It is the biggest borrower in India as it needs funds to finance its various programs. In 2020-21, it borrowed Rs.12.8 trillion and in the current fiscal, plan is to raise another Rs.12.06 trillion. A low interest rate regime will help it more than anyone else both in servicing debt as well as in repayment of loans.

More than a decade ago the Gopinath committee was appointed to go into the issue of interest rates on small savings. It recommended linking rates to yield on ten year G-secs. The idea was that it would be market driven. But in reality it is not so. The RBI pushes its agenda and policy to bring about desirable changes in G-sec rates. Yet, it provided a formula for automatic setting of interest rates with variable spread on different schemes of the government. However, it was not acted upon by
various governments.

Arun Jaitley was the only finance minister who accepted the recommendations and lowered the interest rates. Subsequently, the exercise was given up and the rates on small savings remained higher.

The interest rates on offer now on small savings is close to the level of inflation, 5.03 per cent in January. However, core inflation which does not include food, fuel and light items is close to six per cent. Hence, proposed reduction in rates further cannot be justified. Already savers, who depend on interest income, like senior citizens, have taken a hit on their returns. Even a small spike in inflation will lead to real negative returns.

Negative real rates will hardly boost savings and investments. Even consumption takes a hit as returns are not properly aligned to interest
rate structures.   

Small savings are important for governments too. It is necessary to protect the interest of savers. There should be at least one financial instrument which gives a reasonable, steady and a slightly higher return to savers such as senior citizens or other vulnerable sections.

The cost differential should be transparently borne by the government. The government could issue inflation-indexed bonds. This will protect the principal sum and offer a rate that would be reasonable since it will be adjusted to inflation. If a fiscal incentive is added, it will sweeten the deal for the investor. There is a huge appetite for such risk free, higher return long term instruments.

Almost 85 per cent of the household savings presently is in small savings- NSC, postal, PPF and the like. For all the hype, shares and mutual funds account for just around 3.5 per cent of the total savings (2019-20). 

Stock markets are ruling high. No one knows whether or not a bubble is being built. If the rates (on small savings) are reduced, say after state elections, it may push more investors to stock markets. In the present state, this may not be in the best interests of small, first time investors. Hence government has a responsibility to protect the interests of middle and lower class people. 

The author has four decades of experience in higher education teaching and research. He is the former first vice-chancellor of ISBM University, Chhattisgarh.