Interest cut to hurt retired and rural classes

As one had expected, this is not a budget that introduces any earth-shaking changes, at least in the area of savings. Some tinkering with ta...

As one had expected, this is not a budget that introduces any earth-shaking changes, at least in the area of savings. Some tinkering with taxation and some with interest rates is all that the finance minister has done. And most of what has been done has been along fairly predictable lines.

In terms of the sheer number of people who will be affected, the biggest savings-related change that the budget makes is the reduction in the interest rates on small savings. The interest rate paid on Post Office deposits, National Savings Scheme, Kisan Vikas Patra, Public Provident Funds and similar instruments. This reduction was widely expected, and is certainly in keeping with the general trend of interest rates in the economy.

Still, the fact is that many of these instruments are the main savings vehicles for less well-off people, and they’ll be the ones that will be worse hit. Curiously, the interest cut has been a flat one per cent on all instruments, ranging from the 3.5 per cent Post Office Savings Scheme to the 9.46 per cent KVPs. Thus PO scheme investors, who tend to be retirees and the rural and small-town poor, loose more than a fourth of their interest income. This is indefensible.

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For mutual funds, the biggest change is in the way dividends are taxed. Dividends from mutual funds will be completely tax-free in the hands of the investor. However, debt funds will have to pay a dividend distribution tax of 12.5 per cent. For most investors, this is a big break.

Another possible impact on mutual funds can come from the abolition of long-term capital gains tax on equity investments. This benefit is not available to investments in equity mutual funds. While this could have been a problem for funds, in practice, all it will mean is that equity funds will make it convenient for investors to receive all their gains as (freshly tax-free) dividends rather than as capital gains.

One curious thing that the budget has done is to allow school fees of up to Rs 12,000 per child for up to two children to be treated as investments under Section 88. This is a clearly regressive step. This is the first time that a payout that is not a saving has been allowed under Section 88. This means that of the Rs 60,000 that is allowable under this section, only Rs 36,000 has to actually be a saving. Without a doubt this will bring down the amount that many people will actually save.

(The author heads ValueResearch, that tracks mutual funds and can be reached at dhiren@valueresearchindia.com)

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