Sameer, a 32-year-old client of mine, recently rushed into my office carrying a bunch of papers. He looked agitated as he placed the papers in front of me. The title read “Report of the Committee on Comprehensive Review of National Small Savings Fund. June, 2011”.
“Have you seen this?” he asked. “This states that schemes like Public Provident Fund (PPF) and National Savings Certificate (NSC) will no longer have a fixed rate of interest. They will be linked to the market rate of interest. If that is the case, why would anyone invest in them? I would be better off investing in a debt-based mutual fund. It offers better liquidity and if held for over 12 months it is taxed at the concessional rate of long-term capital gains,” he said.
I smiled. “At first glance it may appear so,” I replied. “But the recommendations have been well thought out. First, interest rates paid on PPF and other small saving schemes have been changed in the past. In the case of PPF, the rates have been reduced from a high of 12% to 8% per annum today. The recommendation merely puts in place a formula based on which the rate will be adjusted upward or downward. It also ensures that the rate once announced by the government will remain the same for a period of one year. So you will have much lower volatility than in a mutual fund. Second, PPF will continue to be included under section 80C as well as provide tax-free returns. Both these tax advantages far outweigh the tax benefits offered by mutual fund investments,” I added.
“But what about those who depend on a monthly income from schemes such as the monthly income scheme (MIS) or the senior citizen savings bonds? Their income will keep fluctuating. How can they continue to live comfortably when their income falls suddenly?” Sameer questioned.
“It is true that the rates will be reset annually. This will have an impact on the income generated from the scheme. However, the committee has capped the change in rate per annum to 1%. This means that the government can raise or lower the rate only up to 1% per year. This will insulate investors from sudden large swings in income. Let us assume that an investor has invested Rs1 lakh in a post office MIS. A drop in interest rate will reduce his income by a maximum of Rs1,000 in that year. This is quite manageable. Remember that the government wants to create a sustainable model for these schemes. So certain compromises are needed. But you will agree that the capping of rates change will save investors from drastic fluctuation in income,” I said.
The need for change
Sameer was beginning to calm down. He realized that today we are in a market-driven economy. Reforms carried out by the government since 1991 have helped the country progress. There have been constant demands and attempts, on the government’s part, to free the administered prices of petrol, diesel and LPG (liquefied petroleum gas). Similarly, financial instruments with administered prices will have to make way for those linked to market rates.
I also informed Sameer of the situation in developed countries. In these countries, there is little difference between the interest rates that small saving instruments offer and what other government securities do.
“But is there anything positive that a middle-class individual like me can look forward to?” Sameer enquired.
“Yes, there is. First, if this system is adopted immediately, your PPF rate will actually rise from next month to 8.2%. Second, currently the PPF annual contribution is limited to Rs70,000 per head. The report recommends that it be raised to Rs1 lakh per head. So, for a married couple with two PPF accounts an additional Rs60,000 can be contributed to PPF per year,” I answered.
“As my financial advisor, in the past you have always recommended that I contribute to PPF both in my name and in my wife’s name. If the discussed changes are implemented, will you still recommend investing in PPF?” Sameer asked.
“PPF has been the best debt product that one can use to build a retirement corpus. That status won’t change. We will still recommend investing in it. However, one will have to wait and watch if the Direct Taxes Code (DTC) makes any further changes. Since DTC is expected to be implemented in April 2012, we will need to evaluate all small saving schemes once again at that time.”
Sameer appeared much more relaxed than at the start of our meeting. He thanked me and left.
The author is a certified financial planner and chief executive, Sardesai Finance.