New Delhi: The Finance Ministry will constitute a committee within a month to suggest ways to link interest on small savings instruments, like public provident fund schemes, with market rates, as suggested by the 13th Finance Commission.
“Within a month, the Finance Ministry will set up a committee in this regard,” an official source said.
Interest on various small savings scheme like PPF and the Post Office Monthly Income Scheme are administered by the Centre, and currently stand at 8% for a maturity of 5-7 years, slightly higher than fixed term deposits of banks of comparable tenor.
The Centre gives each state a part of the amount raised through small savings as a 25-year loan carrying 9.5% interest. However, there is a moratorium of five years on the principal amount.
The administered nature of interest rates on small saving schemes distorts the interest rate structure as well as the loan structure of the states.
The Finance Commission, headed by former finance secretary Vijay Kelkar, said when interest rates on loans from these schemes are higher than market rates, this causes an increase in subscription to these instruments, thereby increasing the flow of loans to states.
With overall borrowings capped by FRBM targets, the states cannot take recourse to open market borrowings. Thus, states may not be able to benefit from the lower interest rates even when markets rates go down, as they are saddled with high inflows from high-cost loans derived from small savings.
Currently, states are allowed to go for market borrowings only till the fiscal deficit widens to 4% of GDP.
Conversely, when market interest rates increase, the subscription to small savings instruments dip and flows from these funds dry up. This was witnessed in 2006-07 and 2007-08, when net flows for many states even became negative.
States have also raised concerns about the tenure of the loan. There is significant mismatch between the maturity of five-seven years for most small savings instruments and the 25-year tenor of loans extended through these schemes to the states.
As such, the Finance Commission recommended that all aspects of the small savings scheme should be examined with the aim of bringing market-linked rates and other much needed reforms to the scheme.