Updated: April 10, 2021 9:39:32 am
Coming as it did on the eve of the new financial year, the notification on reducing the interest rates on small savings schemes quickly made headlines. Not least of all for landing straight in the middle of a crucial polling round in West Bengal — the state with the highest number of people investing in small savings. Unsurprisingly, in under 12 hours, Finance Minister Nirmala Sitharaman ordered the notification to be rescinded. While the electoral consequences of this flip-flop remain to be seen, there is a larger reckoning that is due.
At the heart is the policy decision that ties small savings rates to the G-sec yield — the rate at which the government borrows money through sovereign bonds. This gun-shot wedding between the two, it must be pointed out, has been anything but a smooth affair.
The suggestion to link small savings rates to G-Sec yields was first made in 2001 by Y V Reddy, then deputy governor of RBI. The Reddy committee suggested small savings rates should be reset once a year, allowing for a spread of up to 50 basis points. Reddy’s recommendations were reiterated by his successor Rakesh Mohan and later by an expert group set up in 2009 under Shyamala Gopinath to review the management of the National Small Savings Fund (NSSF).
The Gopinath Committee gave its report in June 2011 and annual revisions in small savings rates linked to G-sec yields got underway effective April 2012. In February 2016, however, the Narendra Modi government decided to reset them on a quarterly basis. As is the case with most policy initiatives of this government, this too escaped a wider debate and ignored expert opinion on the matter.
While advocating that small savings rate be linked to G-sec yields, all expert committees that examined the issue had strongly argued against resetting the rates on a quarterly basis. The fear was it could result in unfair rewards for small savers in the event the G-sec yields remain artificially low for a certain period of time, as it did happen in the pandemic year when small savings rates faced the steepest cut in five years.
Interest on the Senior Citizens’ Saving Scheme was cut to 7.4 per cent, effective from April 2020, from 8.7 per cent before, even though the Gopinath Committee had recommended the rates should never be revised more than 100 basis points in a single year. The rates on the Monthly Income Scheme and the National Savings Certificate were cut to 6.6 per cent and 6.8 per cent, from 7.7 per cent and 8 per cent respectively a year before. On the other hand, average retail inflation in 2020 reached a five-year high of 6.5 per cent, leaving small savers with very little earnings in real terms. In other words, for small savers who hail mostly from the middle class, lower middle class and lower income groups, the pandemic turned into a triple whammy: Battling job losses, higher food prices and a sharp devaluation in the value of their savings and earnings thereof.
The rationale for linking small savings rates to G-sec is premised on the argument that the money collected through these schemes is invested in central and state government securities. While the yield on the latter progressively declined over time, small savings rates remained downwardly rigid — the result being an asset-liability mismatch that threatened the viability of the NSSF. It was also argued that people’s dependence on small savings schemes had significantly declined since formal banking had rapidly expanded. Moreover, for those who used small savings as safety nets there were other alternatives such as old-age pension and other similar schemes.
Notwithstanding the merits of such arguments, it is important to recognise the larger role that small savings have played in contributing to overall economic growth. For decades, small savings have constituted an important source of household savings, funded development programmes of state governments and offered a safe and secure source of income to senior citizens.
The changed policy on small savings is also premised on the belief that markets offer fair outcomes, free of extraneous influences. More often than not, that is not true. The experience of the past year bears it out. While retail inflation spiked, the RBI used every trick in its bag to hold G-sec yields down, and the government used it as a yardstick to announce, on March 31, a steep cut of 50 basis points in the small savings rate. Had it not been for the elections, this would have been in force by now and the real interest earnings of small savers might have turned negative. It may still happen, once the elections are over.
In seeking a withdrawal of the March 31 order, Sitharaman has effectively paused the five-year-old practice of a quarterly resetting small savings rates. She would do well to use this opportunity to make amends and give back small savers what is due to them.
The government could go back to resetting the rates annually, keeping the revision under 100 basis points and allowing small savings rates a spread of at least 50 basis points, not up to 50 basis points, over and above the G-sec yields. Also, it may revisit the suggestion made by the Rakesh Mohan Committee to use a weighted average of G-sec yields over preceding two years — two-thirds weight for the later year, one-third for the earlier year.
Doing this may require setting aside a few thousand crore to fill the resultant gap in the NSSF. If the government could forego Rs 1.6 lakh crore in tax concessions, as it did in September 2019, to help India Inc fix its balance sheets, there is no reason why it can’t make a similar gesture to the millions of underprivileged households.
This column first appeared in the print edition on April 10, 2021 under the title ‘In defence of small savers’. The writer is a senior journalist.
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