The government’s move to keep interest rates on small savings instruments unchanged comes as a setback for small investors. At a time inflation is ruling over 7% and bond yields have risen over 7.4%, not only will the decision result in negative real rate of return – after adjusting for inflation — for savers and pensioners, but the status quo is also likely to prompt banks to go slow in hiking deposit rates.
Are the rates attractive?
Considering that retail inflation hit 7.97% in April and 7.04% in May, the existing rates on small savings schemes might have disappointed savers even though these are higher than banks’ fixed deposit rates. The RBI expects retail inflation to be above the upper tolerance level of 6% until the end of the year.
As per Thursday’s decision, schemes like Public Provident Fund (PPF) and the National Savings Certificate (NSC) will continue to carry an annual interest rate of 7.1% and 6.8%, respectively, in the first quarter of the next fiscal. The one-year term deposit scheme will continue to earn 5.5% interest in the second quarter. Term deposits of one to five years will fetch a rate in the range of 5.5-6.7%, to be paid quarterly, while five-year recurring deposits will earn a higher interest of 5.8%.
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Barring PPF and Sukanya Samriddhi Yojana, all other small saving instruments are currently fetching negative real returns amid high inflation. What’s more, as the RBI is expected to jack up the main policy rate – repo rate – further to bring down inflation, savers will have expected more returns from small savings schemes and bank deposits.
What does it mean for banks and savers?
Banks are now unlikely to go for a major hike in deposit rates. Had the government hiked small savings rates, they would have been forced to go for a steeper hike in deposit rates to prevent money flow from banks to small savings schemes.
Further, when stock markets boomed in 2021 after the crash of March-April 2020, investors pumped a record amount of money into stocks and mutual funds. Now with markets showing huge volatility in the wake of rising rates and foreign portfolio outflows, savers are looking at bank deposits and small savings. Much will now depend on the quantum of the rate hike that the RBI will announce in the coming months.
What have been the recent trends in interest rates?
Small savings rates are linked to yields on benchmark government bonds, but despite the upward movement in G-Sec (government securities) yields, the government has not increased interest rates. As of Thursday, the 10-year benchmark bond yield has risen to 7.45%, up 140 basis points in the last one year. The RBI has also raised the repo rate by 90 basis points to 4.90 % during the April-June quarter. The interest rates on small savings were slashed by 40-110 basis points for the first quarter of 2021-22 but the decision was later rolled back, with the Finance Minister saying the “orders issued by oversight shall be withdrawn”.
What has been the impact of negative returns?
While inflation is now over 7%, the one-year bank fixed deposit rate is now 5.3% (SBI). It means depositors are losing money after adjusting for inflation. There aren’t many options for savers and depositors. Markets are risky and volatile. They can’t play around with retirement money. On top of this, the country lacks a proper social security system, although government and semi-government employees get pension after retirement. Technically, negative real rates discourage savings and boost consumption. This, in turn, may fuel more inflation and lead to even more negative real rates. Keeping interest rates too low for too long can have negative consequences.
How have banks responded?
After the RBI hiked the repo rate since May, banks have started raising deposit rates. Earlier this month, SBI raised rates by 15 to 20 basis points on some retail domestic term deposits below Rs 2 crore. The rates for senior citizens are higher by 50 basis points for these tenures. Other banks have also increased rates. The hike in bank deposit rate will also depend on the credit demand, which has now started showing signs of growth.
The banking system has been sustaining a liquidity surplus since June 2019 on account of build-up deposits due to higher growth in bank deposits versus the credit disbursement, except for the last couple of fortnights. It is, however, important to note that if small savings rate are not raised, banks would not be forced to raise rates, unless they need to mobilise funds for credit demand. Had the government raised small savings rates, banks would have been forced to raise fixed deposit rates.
What can investors do?
While one can strategise to invest in a good debt product yielding better returns, experts say equities are the best option for beating inflation and generating positive real rate of return.
While small saving instruments are offering lower rates than 10-year G-Sec yields, trading at around 7.4%, financial advisors say individuals in the highest tax bracket can go for high-rated debt papers and invest in debt mutual funds that are also more tax-efficient. “Debt investors can instead go for target maturity funds that invest in GSec/PSU bonds and state securities. If investors invest for five years they can get post-tax return of around 6.5%. Even for a three-year period, investors will be able to get 5.5% post tax,” said Surya Bhatia, founder, AM Unicorn Professional.
Vishal Dhawan, founder and CEO Plan Ahead Wealth Advisors said that while individuals in the highest tax bracket can go for target maturity funds for safety of capital, “ideally investors should go for short maturity products so that on maturity they can reinvest at a higher rate as the interest rates are on an upward trajectory. However, for protection against inflation, one should look at equities despite the discomfort as only equities can provide protection against inflation”.
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