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Hike in small savings return a sweet pill

Interest rate hike is a good news,but the devil lies in the details says Ritu Kant Ojha

Written by Ritu Kant Ojha |
November 14, 2011 3:06:41 am

If you had planned for your future corpus thinking that your Public Provident Fund (PPF) and other small savings options would give almost fixed returns,be ready to make fresh calculations. From December 1,the small savings returns would become market-linked,aligned with the G-Sec rates (government securities). To address the issue of asset-liability mismatch in the National Small Savings Fund (NSSF), the central government has moved towards making returns from small savings instruments benchmarked against the government securities of similar maturities.

Being market linked,the rate of return would come down whenever there is a downward revision of interest rates,making it difficult for you to work towards a long term financial goal,like building retirement corpus,through instruments like PPF.

Why market linked

The Thirteenth Finance Commission in its report had recommended that all aspects of the design and administration of the NSSF be examined with the aim of bringing transparency,market linked rates and other much needed reforms to the scheme. As a follow- up to this recommendation,the central government had constituted a “Committee on Comprehensive Review of NSSF” on July 8,2010,headed by Shyamala Gopinath,the then deputy governor,Reserve Bank of India.

The asset-liability gap in the National Small Savings Fund (NSSF) has reached an alarming level of R 36,932.38 crore. Over the years,due to the loss on the income and expenditure account,there has been an excess of liabilities compared to assets built over the years,the committee had reported.

“If the asset-liability mismatch is allowed to continue,it will create an unsustainable fiscal burden on the government,” Rajiv Kumar,member of the Committee and secretary general,FICCI had earlier said on the release of the report.

Based on the review report and recommendations made by various departments,states/ UTs and agent associations,government arrived at following decisions:

Rationalisation of schemes

* The maturity period for Monthly Income Scheme (MIS) and National Savings Certificate (NSC) will be reduced from 6 years to 5 years.

* A new NSC instrument,with maturity period of 10 years,would be introduced.

* Kisan Vikas Patras (KVPs) will be discontinued.

* The annual ceiling on investment under PPF will be increased from Rs 70,000 to Rs 1 lakh.

* Interest on loans obtained from PPF will be increased to 2 per cent p.a. from existing 1 per cent p.a.

New interest rates

* Interest on post office savings account increased from 3.5 per cent to 4 per cent p.a.

* The rate of interest on small savings schemes will be aligned with G-Sec rates of similar maturity,with a spread of 25 basis points (bps) with two exceptions. The spread on 10 year NSC (the new instrument) will be 50 bps and on senior citizens savings scheme (SCSS) 100 bps. The interest rates for every financial year will be notified before 1st April of that year.

* The 5 per cent bonus on maturity of MIS will be discontinued.

No fixed return on PPF

PPF forms an integral part of the long term planning,especially of the middle and the lower middle income groups. The return on PPF has been increased to 8.6 per cent for this year. However,going forward there would be no fixed return element attached to it.

Traditionally the future projections for PPF corpus,a product with 15 year maturity period,revolved around an approximate annual compounding return of 8 per cent. Most people use their provident fund for purposes such as children’s marriage,higher education,or buying a house. “It will be difficult to project future income based on PPF returns. Annual adjustments depending on the prevalent PPF rate would have to be made to arrive at the right amount”,says Kiran Telang,a Mumbai based financial planner.

“PPF rate of 8.6 per cent is non-taxable and a boon for investors looking to build their retirement corpus through debt allocation. 8.6 per cent non-taxable is equal to 12.30 per cent for investor in 30 per cent tax bracket or 10.75 per cent for investor with 20 per cent tax bracket. Investors should utilise complete limit of R 1 lakh”,suggests Neeraj Chauhan,a financial planner. 

Unattractive returns

In the unbanked rural and semi-urban areas,post office savings are immensely popular and are trusted due to the sovereign guarantee it carries.

However,experts feel that with changing times small savings instruments are no longer as attractive as they used be. With banks offering 4-6 per cent return on savings accounts,company fixed deposits giving 9.5-10 per cent returns,and secured non-convertible debentures about 12-13 per cent,the options for the investors are aplenty.

Before taking any investment decision do account for inflation,currently hovering around 9-10 per cent. For example,if the average inflation for the next 10 years remains at 8 per cent and the return from 10 year NSC is 8.7 per cent then the real return would be only 0.7 per cent. “For any long term goal,a judicious mix of debt and equity is required which would at least give 3 to 4 per cent higher return than average inflation”,suggests Suresh Sadagopan,CEO,Ladder7 Financial Advisories.

With “fixed return” gone,investors would do well to evaluate other options. While at this point the increase in small savings rates of may look attractive,it may well prove to be a sweet pill in the longer term.

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