Small Savings Rate: To Cut Or Not To Cut?

Those who argue against a cut say that small savers shouldn't be burdened any more than they're with weak growth and rising inflation. The other side leans on economic logic to say that one set of savers can't get compensated more than others.

So far, the Indian government has avoided cutting rates on these instruments for at least a year.

Interest rates on small savings schemes were last reduced by 70-140 basis points for the April-June 2020 period. Since then, apart from an incident of "oversight", wherein the government announced a cut only to withdraw it within hours, rates have been held steady. For the July-September quarter, once again, the government has kept rates unchanged, it said in a notification on June 30.

In theory, rates on these schemes are expected to track yields on government securities as recommended by the Report on the Committee of Comprehensive Review of National Small Savings Fund back in 2011. To avoid undue volatility, the committee had agreed that administered rates should neither be raised nor reduced by more than 100 basis points from one year to the next, even if the average benchmark interest rates rise or fall by more than 100 basis points.

In practice, the government has struggled to stick to any sort of benchmark to adjust these rates.

According to Rajiv Kumar, vice chairman of NITI Aayog and a member of the Shyamala Gopinath-led committee, the status quo should continue. This is in the best interest of savers, he told BloombergQuint.

Kumar may be taking the government's official line but others, too, see merit in the status quo at the current time. This isn't just because of the prevailing economic strain but also because of the way the Indian central bank is managing bond yields.

Devendra Kumar Pant, chief economist at India Ratings and Research said that yields are reflecting the extreme liquidity surplus the central bank has maintained and future growth-inflation dynamics. Therefore, at a time when demand is struggling, the government has left interest rates untouched, primarily from the point of view of savers whose major source of income is interest from these instruments, Pant said.

A person who has been closely involved with the issue in the past shared a similar view.

This person, while speaking on condition of anonymity, said bond yields today aren't entirely market-determined because of RBI intervention.

This aggressive management of market interest rates is visible in the negative real rates prevailing. For instance, the 364-day treasury bill yield is at 3.89%, well below the one-year forward inflation forecast of 5.3%.

Given these market distortions, the expert cited earlier said an exception may be warranted. With inflation inching upwards along with the current economic scenario, the government may not want to inflict more pain by slashing rates on small savings schemes, this person said.

Subhash Garg, former economic affairs secretary, disagrees and thinks the government shouldn't veer too far away from the formula.

"There are some socio-economic obligations for senior citizens and some other sections of the society, but that should be met by direct transfers rather than going for the indirect route of giving them 1% or 2% extra over the bond rates," Garg said.

The other side of the argument is that one set of savers should not benefit where others are suffering. For instance, banks have reduced fixed deposits rates over the past year to reflect lower policy rates and the surplus liquidity position.

Don't banks also have small savers as depositors? And are subscribers to small savings schemes really that different?

The expert cited earlier agreed that a lot of high-net worth individuals also put their money in small savings schemes.

You want to protect small savers, but should you be protecting the HNIs, this person asked. While the Shyamala Gopinath-led panel had tried to weed out HNIs from these schemes, it had failed to find an appropriate methodology. The government should use tax policy to disincentivise large investors from small savings schemes.

However, keeping small savings rates high also keeps the money flowing in. For the government, which has been borrowing more and more from the National Small Savings Fund, this proves to be a perverse incentive. Eventually though, it adds to the government's own cost of borrowing.

Those who have watched the economy for years know that decisions on small savings rates are as much political as they are economic.

While Garg says the socio-economic aspect of small savings instruments should not be a material consideration, Pant believes that social considerations always play a more material role in the final rate-setting decision.

It is socio-economic, but really it is economic, the expert quoted above said. That’s why it is important to define a small saver and see who these schemes are benefitting, this person said.

Ask NITI Aayog's Kumar the same question and this is what he has to say: "In policy making, there is no issue, which is a purely economic issue. Every issue is either a socio-economic or a political-economy issue."