Amid rising yields on government securities, the Finance Ministry last week hiked the interest rates for some small savings schemes by 20-110 basis points for the January-March quarter. While the hike will serve as protection against high inflation and interest rates, the small savings rates are still below desired levels. The hike in small savings rates This is the second consecutive quarter when the rates for small savings schemes have not been hiked across the board. While interest rates have been kept unchanged for a 5-year recurring deposit, the public provident fund scheme and the Sukanya Samriddhi scheme, rates for 1-year, 2-year, 3-year and 5-year time deposits and the senior citizens savings scheme have been hiked for January-March. In October-December, the Finance Ministry had hiked interest rates on some of the small savings schemes by 10-30 basis points, after keeping them unchanged for nine consecutive quarters. Interest rates were marginally hiked for 2-year and 3-year time deposits, the senior citizens scheme and the Kisan Vikas Patra. Rising interest rate cycle Coming amid a higher inflation rate and a rising interest rate cycle, the hike in small savings rate is seen as necessary to protect savers, especially senior citizens. The view within the ministry is to balance the interests of senior citizens and persons saving in instruments without tax benefits, along with keeping the interest rate for small savings in check, as it essentially translates into a higher interest cost for the government when it borrows against the National Small Saving Fund. Fixing level of rates Interest rates on small saving schemes are reset quarterly, in line with the movement in benchmark government bonds of similar maturity. Typically, the small saving rates are linked to yields on benchmark government bonds, but despite the movement in G-sec yields, the interest rate changes have not strictly matched the yield movements over the past two years. The reference period for small savings rates for the January-March quarter is September-November, when the yield for five-year government securities rose about 15 basis points. Are the hikes enough? Savers are concerned about the real rate of return on their investments in small savings schemes. If both inflation and interest rates are high, savers have a low real rate of return. Retail inflation rate has remained above 6 per cent most of last year, easing only a bit in November to 5.88 per cent. Meanwhile, the Reserve Bank of India has hiked the key policy rate by 225 basis points, with the repo rate now at 6.25 per cent. Most small savings schemes, till the beginning of the previous quarter, were fetching less than 6 per cent interest rate. The RBI in its Monetary Policy Report released on September 30 had noted that with government bond yields increasing, the revised small savings rates were 44-77 basis points below the formula implied rates. What does it mean for savers? While young investors can go to equity markets through mutual funds for their wealth creation, conservative investors and those who have retired or are nearing retirement rely mostly on small savings schemes, monthly income schemes or fixed deposits. While some increase in rates on certain instruments is good news for investors of small saving instruments, barring PPF, Sukanya Samriddhi Yojana and senior citizens' savings scheme, all others are currently fetching negative real returns. Even the senior citizen savings scheme is generating negative returns for someone in the highest tax bracket. Considering that the retail inflation is around 6 per cent, the post tax return on most of the small savings instruments will not even cover inflation for those in the highest tax bracket. For example, the five-year time deposit earns 7 per cent, but the post-tax return for those falling in the 20 per cent and 30 per cent tax slab would stand at 5.5 per cent and 4.8 per cent. For investors who invest in these schemes for wealth creation, over a period of time, most of these instruments won't serve the purpose. What can investors do? As the inflation and interest rates go down, it will provide a boost to equities. Those who are comfortable with equities should look to them when it comes to saving for retirement. Financial advisors say that individuals in the highest tax bracket can go for high rated debt papers and invest in debt mutual funds, which are also more tax-efficient. However, for protection against inflation, equities remain the best bet.
