Small Savings Collections: Banks’ Loss Is Government’s Gain

A period of tight liquidity in the banking system, which lasted for over a year, was often blamed on the sluggish inflows into bank deposits. Deposit growth was running below credit growth and that left banks feeling the pinch. A consequence of the tight liquidity was that banks were unable to pass on the interest rate cuts announced by the Reserve Bank of India.

This slower deposit growth was blamed on a number of factors, among them weaker income growth. Not enough attention, though, was paid to the role of the government and small savings schemes run by it in weaker deposit growth of banks and, hence, in poor transmission of policy rate changes. The gamut of these small savings schemes run from post office savings and term deposits to National Savings Certificates and Public Provident Fund.

Reserve Bank of India data on small savings suggests that collections have been running at a pace well above last year’s. The net inflow into small savings schemes stood at Rs 65,838 crore between April-November 2018-19, the data collated by BloombergQuint shows. This is nearly 63 percent higher than the net collections in the same period last year. RBI data on net collections is not available beyond November 2018 and hence the comparison has been restricted to the April-November period. For the full financial year 2017-18, collections stood at Rs 72,898 crore, the data shows.

To be sure, collections into small savings schemes can be volatile and the full year trend may differ from the data available so far. However, given that small savings interest rates continued to remain higher than bank deposit rates, collections may have remained strong through the rest of the year as well.

The Rate Differential

Apart from any tax incentives, a key reason for higher collections across small savings schemes is the difference in interest rates offered by government run schemes and those offered by banks.

Until September, the rates offered on government-run term deposits of 3-year and 5-year maturities were higher than the interest rates offered by State Bank of India. For the September-December quarter, the government actually raised the interest rates across small savings schemes. Post this revision, 2-year, 3-year and 5-year deposits parked with the government pay interest rates higher than what SBI pays. These rates were retained in the January-March and April-June quarter.

When compared with a large private sector bank like HDFC Bank, deposit rates offered by government small savings schemes are lower in the 1-year, 2-year and 3-year buckets but still higher in the 5-year bucket.

Apart from a hike in term deposit rates, the government also hiked the interest rate on public provident fund collections to 8 percent from 7.6 percent earlier.

The higher rates, together with tax benefits offered on some schemes, can create a substitution effect between bank deposits and small savings scheme, the RBI noted in a May 11 study on the phenomenon of weak deposit growth. While income growth has the strongest impact on deposits, a substitution effect between different savings instruments can impact deposit growth over the short run, the study suggested.

The income elasticity of deposit growth is 0.85, turning out to be the most relevant determinant in the short-run as well. On the other hand, small savings collections drag down deposit growth with substitution effects.

RBI Study On Deposit Growth

This, in turn, would prevent lenders from cutting deposit rates beyond a point and hurt smooth transmission of policy rate cuts.

Incentive To Keep Rates High?

The question to ask if whether the government is setting small savings rates higher than they should and why?

Back in 2011, a committee headed by former RBI deputy governor Shyamala Gopinath had recommended that interest rates on small savings schemes be calculated by adding a mark-up (25-100 basis points) to the average of the government bond yield in the preceding quarter.

The government, however, has not strictly followed this rule. The quarterly revisions announced by the government often result in a delayed adjustment in small savings rates. Also, the direction of rates has not always followed bond yields as they should.

For instance, small savings rates for the January-March quarter were held steady, even though the benchmark 10-year bond yield declined from 7.98 percent to 7.36 percent in the October-December period.

While the government does not give a rationale for its interest rate strategy on small savings, the increased collections across such schemes help the government, which is now borrowing a considerable amount from the National Small Savings Fund.

In FY19, the central government borrowed about Rs 1.25 lakh crore from the NSSF to help finance its deficit. In addition, government agencies also borrowed from the pool. Food Corporation of India, in particular, borrowed Rs. 1.86 lakh crore from the NSSF in FY19 compared to Rs. 1.21 lakh crore in FY18 and Rs 70,000 crore in the year before that.

These borrowings are expected to remain high in FY20.

“India Ratings and Research believes the Union Government may end up borrowing more from the national small savings fund (NSSF) than budgeted for FY20,” the rating agency said in a release after the interim budget. As per the interim budget, the government intended to borrow 21 percent of its fiscal deficit from NSSF in FY20. This is marginally lower than the 22.4 percent borrowed in FY19 but significantly higher than 3 percent of fiscal deficit financed from this pool in FY15, India Ratings pointed out.

This high reliance on small savings can create an incentive for the government to keep rates artificially high, which in turn would hurt transmission of policy rate cuts announced by India’s monetary policy committee this year. The easiest way to avoid this is to follow the interest rate formulas suggested by the Shymala Gopinath committee, which would ensure that key interest rates in the economy move in the same direction.