The second half of 2011 saw a sudden rush of changes in the small savings space. Recommendations made by the Shyamala Gopinath committee to make small savings scheme market linked got accepted and implemented from December this year. The rate of interest on various small savings instruments is now pegged to the government securities (G-sec) rates of similar maturities. But don’t worry, you don’t have to track G-secs or worry about changing rates through the year. The government will announce the rate of returns on small savings instruments once a year on or before 1 April.
Though the government has always been at liberty to alter the rates of interest, but found changes difficult— downward would cause public uproar and upwards would just cost the government more. The status quoists would win and this kept the Public Provident Fund (PPF) rate at 8% for the last eight years—a period that saw a policy rate peak and trough of 8.50% and 4.75%, respectively. To make the return on small savings more realistic, the committee decided to link them to the average yield on G-secs of similar maturity during the preceding calendar year. But you do not get the G-sec rate, you get G-sec plus 25-100 basis points (bps), depending on the instrument. Here’s a round up of what you get from which instrument and whether it still remains investment-worthy.
Cause: PPF and SCSS, among others, made market-linked
PPF retains its edge
PPF returns are now 25 bps more than the 10-year maturity G-secs. This means PPF will give a quarter of a percentage point more than the average yield on 10-year G-secs during the preceding calendar year. For the current fiscal the rate is 8.6% against 8% earlier. Thus, the contribution you make this year as well as the entire previous balance would earn 8.6% interest during the current fiscal. Currently PPF has an undisputed edge over other small savings instruments because of the tax breaks. Your investment in PPF qualifies for a tax deduction up to Rs 1 lakh of section 80C of the Income-tax Act. On withdrawal the maturity corpus is tax exempt. A 8.6% risk free, tax free rate makes PPF a first choice in your debt portfolio. What if interest rates fall? “Mostly in a high inflationary situation, yields on G-secs rise due to the fear that the Reserve Bank of India would intervene and may increase policy rates. Accordingly, the rates offered on small savings instrument would be higher during rising inflation scenario. In contrast, during low inflation period, yields on G-secs fall and so would the interest rate offered on small savings instruments,” says Satkam Divya, business head, Rupeetalk, a NetAmbit Venture. But whether rates go up or down, at any given point in time, PPF would still remain the best product because of the spread and tax incentive. The other good news is that you can now invest another Rs 30,000 in PPF as the limit has been raised from Rs 70,000 to Rs 1 lakh from this fiscal year.
Also see | The changes (PDF)
Senior citizens get a 1% boost, but MIS loses some steam
The vehicle for retirement money, the Senior Citizen Savings Scheme (SCSS) has got the biggest boost. You now get a 100 bps more than the G-sec rate and for the current fiscal the rate is unchanged at 9%. This scheme is meant for individuals above 60 years of age. It is a five-year investment vehicle meant to provide an income stream coming every quarter at the specified rate of interest. On maturity it returns the principal. Your investment qualifies for a deduction under section 80C. However, the income is taxable. Given that specified five-year bank fixed deposits (FDs) get the same tax treatment, choose between SCSS and bank FDs to pick the one with higher interest rate. Right now five-year bank FDs are clear winners as they give 10% return. The post office monthly income scheme now gets 25 basis point more than the five-year G-secs and does not compare well with bank FDs and SCSS. Accordingly, the returns have been fixed at 8.2% for the current year. Also, as per the recommendations the bonus of 5% on maturity has gone and now the tenor is five years instead of six years.
Other investment products
The government has done away with Kisan Vikas Patra (KVP) mainly on account of its vulnerability to be misused as it is a bearer like instrument. In a bearer instrument the presenter walks away with money. There were fears that KVP was being used for money laundering.
Also in order to give you more long-term options, the government has introduced a new National Savings Certificate (NSC) for 10 years. The returns on newly launched 10-year NSC has been benchmarked to 10-year G-secs with positive mark-up of 50 bps. For this year, the rate is 8.7% per annum. The tenor of the older NSC has been reduced from six years to five years now. The returns on the five-year NSC would be benchmarked to average yield of five-year government bond with a positive spread of 25 bps. During 2011-12, you would get 8.4% per annum against 8% earlier. The investments in NSC qualify for a deduction under section 80C. However, on maturity you need to pay tax.
The post office time deposits are now market linked as well. To improve flexibility, you now have the option of premature withdrawal. But if you opt for premature withdrawal, you would be paid 100 bps less than the time deposits of comparable maturity. Also, if the premature withdrawals are made between 6 and 12 months of investment, you would be paid post office savings account interest rate, which is now 4% per annum. In comparison, the practice among banks varies widely. While, most banks deduct premature withdrawal penalty of 0.5-2% from the rate applicable for the period deposit has remained with the bank or the contracted rate, whichever is lower, some banks such as State Bank of India do not charge any premature withdrawal for deposits of up to a particular period. Also, currently banks deposits are offering higher rate than post office FDs.
The reforms in the small savings scheme was long overdue and has brought much needed transparency in these schemes. The interest rate on all these instruments for the current fiscal year have either gone up or has remained at its earlier level. However, while investing keep in mind that rates may move either way depending upon the macroeconomic situation.
Illustration by Jayachandran / Mint