RBI rate cut: Small savings to feel the squeeze

Investors in small savings schemes should get ready for a lower interest rate regime as inflation takes a slide and banks prune their lending rates to stay competitive.

Written by Shruti Srivastava | Updated: October 9, 2015 12:58 pm
rbi, rbi rate cut, repo rate cut, rbi repo rate cut, rbi governor raghuram rajan, rbi basis point cut, rbi loan rate cut, rbi news, reserve bank of india, business news, economy news, indian economy, indian express news Even though rates on small saving schemes have been linked to yields on government securities of comparable maturity, experts said that the interest rates on these savings need to be rationalised to reflect the economic shift in wake of declining inflation.

The government’s announcement that interest rates offered by a range of small saving schemes would be reviewed in the wake of the RBI repo rate cut has reignited the debate on the impact that such schemes have on the lending rates of banks. Experts, however, are clear. Going forward, those investing in small savings scheme should be prepared for a lower-interest-rate regime as inflation takes a slide and banks prune their lending rates commensurately.

Even though rates on small saving schemes have been linked to yields on government securities of comparable maturity, experts said that the interest rates on these savings need to be rationalised to reflect the economic shift in wake of declining inflation. The consumer price index (CPI) stood at 3.66 per cent during the month. This is within the comfort zone of Reserve Bank of India, which has set a target of 6 per cent for 2016.

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The banks have for long been arguing that the transmission of monetary policy easing has not happened so far due to high small savings rates. The RBI has reduced rates by 125 bps to a four-and-a-half-year low of 6.75 per cent while banks have transmitted only up to 70 bps in their base rate. This is because, banks argue, high rates on small savings schemes run by the government make their fixed deposits uncompetitive and in turn does not allow them to reduce the cost of borrowing.

While the leading banks are currently offering 7-8 per cent interest rate on a five-year fixed deposit of less than Rs 1 crore, small savings command rate ranging between 8.4-9.3 per cent, making it difficult for banks to reduce deposit rates. Hence, the reluctance to transmit the policy rate cut by RBI to borrowers.

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“The weak transmission until recently has led to the banks citing higher small savings rate as one of the key hindrances for them to lower their deposit rates that, in turn, will allow them to lower the lending rates. Small savings directly compete with bank deposits for household savings. The deposit growth has been correcting sharply since FY15 essentially due to negative real rates of return. Remember, consumer inflation had stubbornly remained elevated between 8-10 per cent during FY11 to FY14. Since January 2014, the real rate has turned positive, which with a lag will support deposit growth. With improved alignment of small savings rate to market rates, banks will be better place for lowering their deposit rates without seriously affecting mobilisation,” Shubhada Rao, chief economist, Yes Bank, told The Indian Express, adding that banks are the largest intermediaries of domestic savings.

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Small saving schemes and rationalisation

In July 2010, the government had constituted an expert committee led by RBI’s then deputy governor Shyamala Gopinath for a comprehensive review of the National Small Savings Fund (NSSF), which includes Post Office savings account, Post Office time deposits ( 1,2,3 and 5 years), Post Office recurring deposits, Post Office monthly account, senior citizens savings scheme, National Savings Certificate ( VIII-Issue and IX-Issue), Public Provident Fund, Kisan Vikas Patra and Sukanya Samriddhi Account.

It was asked to review the existing parameters for the small saving schemes in operation and recommend steps to make them more flexible and market linked. Among other things, the committee recommended benchmarking the interest rates on small savings schemes to the yield on government bonds with a spread of 25 basis points, to be revised annually.

However, the time has come where small savers should be prepared to get lower returns on their deposits, Rajiv Kumar, former secretary general of Ficci, who was a part of the Gopinath Committee, said that. “Government can’t and should not offer such high rates. The notion that small savers are from deprived section is misplaced. The scale does not matter, the margin does,” he said while ruling out any impact of the reduction in rates on the savings behaviour of people.

According to the government data, while the outstanding balance under all National Savings Schemes and Saving Certificates in Post Office stood at over Rs 6,15,021.56 crore as on March 31, 2014, aggregate bank deposits were Rs 77,05,560 crore in the same period. The aggregate bank deposits stood at Rs 85,33,290 crore in 2014-15.

Impact of review on small savers

Madan Sabnavis, chief economist, CARE ratings, cautioned that the overall savings behaviour of people may get impacted if the rates are lowered. “If you look at small savings, they have not been moving up. Funds don’t get transferred from one bank to the other only on the basis of high rates. Small savings is more of a rural phenomenon. Banks feel disadvantaged because of the high rates offered by the small savings scheme but I don’t think that is happening. Rationalisation is though needed as there are schemes with no limits and the government is paying higher cost,” he said.

Another fallout, as pointed out by Abizer Diwanji, partner and national leader, financial services, EY, is that if the rates are revised downwards, people investing in such schemes may get lured by dubious or ponzi schemes that promise to offer astronomical returns. However, financial inclusion is unlikely to be adversely impacted as it is behaviour driven and not rate driven.

“This indicates that the government does not want people to save rather they want them to spend. The government wants the country to move towards consumer economy. What incentives will people have if they reduce the rates,”

CPI leader and Rajya Sabha member D Raja said. DL Sachdev, national secretary, All India Trade Union Congress said: “We will not allow the finance minister to intervene in interest rates at the level of employees’ provident fund.”

The way forward

The government has budgeted Rs 22,408 crore from small savings to meet its budget deficit. Also, reducing the rates significantly will not be easy as it may channelise the money into gold and real estate, leading to generation of black money. While the small savings schemes may give lower returns going forward, people would still have options to invest in tax-free bonds and corporate deposits which offer stable and higher rates, financial planner Vishal Dhawan said.

He added that those investing in these schemes need stability and predictability and corporate deposits fit into their needs.

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  1. A
    Atis Mitra
    Oct 11, 2015 at 9:24 pm
    The fraud regarding the downing of inflation is being spread by cohorts and supporters of BJP
    Reply
  2. b
    blogger3110
    Oct 9, 2015 at 11:18 am
    Senior citizens must get a higher rate of interest as the vast majority of them are dependent on bank interest If interest rates are reduced senior citizens should get an extra 1% as compensation
    Reply
  3. J
    JYOTHIKUMAR.K
    Oct 9, 2015 at 8:08 am
    The governments approach to interest on deposits by public in banks and post offices is a skewed approach. About two decades ago the interest rates were around 15 to 16 percent by the nationalised banks and post office deposits but the inflation rates and prices of essential commodities were about a quarter of today's w and retail price band. When ever the inflation increased there was no corresponding increased in interest rates.Now the argument for reduction that inflation is down is illogical. The real reason is the Government wants to lend to borrowers cheap money to stimulate growth which happened even when the interest rates were high. The nationalised banks non performing ets are making them not a profitable business as thebig borrowers are big defaulters. The private Banks lend only after due diligence and therefore they carry low NPAs. Government keeps funding the Nationalised banks and the NPAs are camaflouged In the account books every year. For all the inefficiencies of Govt banks the depositors are penalised.The worst affected sections are the retirees without any pension .The most reasonable solution is to balance the interest rates directly to link them with inflation index both for lending and deposits. When the government servants are given Dearness allowance linked to Consumer price index (inflation linked) the same logic should be applied to banking operations. If a depositor deposits certain amount for a specific time period at at today's rate of interest and if the inflation goes up will he get a higher interest automatically.? Therefore the proposal and implementation of Government and Reserve Bank is not logical both for bank deposits and small savings. The above step will lead to mushrooming of non conforming ,unregulated private financial insutions many of which may turn to be short lived depriving depositors their funds.
    Reply
  4. N
    Narendra M
    Oct 9, 2015 at 8:31 am
    (1) The Claims about fall in inflation rate which have been made to pressurize governor of Reserve Bank of India to make a rate cut are not correct. Consumer Price Index (CPI) and not W Price Index (WPI) should be considered when we talk about inflation control. My fear is that partial failure of monsoon may actually lead to high inflation later this financial year and the claimed benefits of recent fall in CPI/WPI may be negated later in Jan-March 2016. (2) Yes, it is agreed that home and other loans would become cheaper for a while but is it that the Central government should be concerned about only those who borrow and not about those who deposit their hard-earned savings with banks? (3) We already see a trend of falling rates of interest on banks’ term deposits and if interest on small savings schemes too is reduced, senior citizens and others who depend on interest on bank deposits or Monthly Income Plan of India Post will have very hard days ahead. I fear that these sections of our potion will face capital erosion to meet daily expenses. I also believe developments in coming months will decide whether the rate cut has brought in the intended benefit to those for whom it was meant.
    Reply
  5. B
    bangalorean
    Oct 11, 2015 at 1:13 am
    i fully agree with you.
    Reply
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