The finance ministry’s decision to cut the short-term small savings rates signals an intent to reform by the government on the eve of the budget session. On Tuesday, the ministry cut the interest rate paid on post office savings of one, two and three-year terms, Kisan Vikas Patra (KVP) as well as five-year recurring deposits, by 25 basis points. The ministry has also announced that the rates on such small savings schemes would, henceforth, be revised every quarter. Interest paid on small savings instruments, fixed arbitrarily by the government, has been higher than the interest rates prevailing in the markets. This has been cited as one of the key reasons for poor monetary policy transmission in the economy. Banks were unwilling to cut the interest rates they paid on deposits, and in turn, the rates they charged on loans, even when the Reserve Bank cut interest rates repeatedly. Since the start of 2015, the RBI has cut interest rates by 125 basis points, yet the effective reduction passed on by the banks was just about 60 basis points.
The key benefit from the move would be the improvement of investor sentiment and activity through better policy transmission. The persistently high lending rates have been a dampener for an investment-starved economy. There is a flip side too: Small savers will not get as good a return. However, it is expected that the overall gains to the economy from lower interest rates will outweigh the benefits to small savings deposit holders. Actually, that is the reason why this policy move has always been difficult to undertake. It also explains why the government did not reduce interest rates across all small savings instruments.
To be sure, the government left unchanged the interest rate paid on the long-term small savings instruments, such as the public provident fund (PPF), the national saving certificate or the new Sukanya Samriddhi Account Scheme (SSAS), which are politically more sensitive. At present, there’s a significant gap between the rates paid on these — ranging from 8.7 per cent for the PPF and 9.2 per cent for the SSAS — and the 7.8 per cent yields on 10-year government bonds, a proxy for market rates. In fact, the Employees’ Provident Fund rate has been increased by 0.05 per cent. The non-inclusion of these schemes will certainly hold back transmission. Yet, the government has started the process of aligning the interest rates in the market, which is crucial to reviving investment.
