Since April 2016, interest rates of all small saving schemes have been linked to government bond yields and are now recalibrated on a quarterly basis. Over the last couple of years, interest rates of most small savings schemes have declined about 1 percentage point. For instance, the rate on Senior Citizen Savings Scheme has come down from 9.3% in FY2015-16 to 8.3% now.
While there was no change in the small savings rates in the October-December 2017 quarter, the rates were reduced for most schemes for the January-March quarter: Public Provident Fund (PPF), National Savings Certificate (NSC) and Kisan Vikas Patra were reduced 20 basis points for the January-March 2018 quarter. Senior Citizen Savings Scheme, however, continues with 8.3%.
Returns on small savings instruments were linked to the market in 2011, and were then adjusted annually. This was done so that the interest rate on these could be pegged to the average government securities (g-secs) yield with similar maturity in the preceding year. However, since January-March 2015-16, after substantial cut in policy rates by the Reserve Bank of India, they are being reviewed every quarter. Since then, rates have been declining gradually.
Meanwhile, g-sec yields have risen sharply in the past few months, and there has been a spike after the Union Budget 2018 was presented. The yields went up from 6.414% on 6 February 2016, to 7.562% on 2 February 2017.
There are two forces driving this change. “First, the deficit numbers for current and the next year are higher than what was initially projected. That has been a worry for the market... and the Budget did not do enough to address these concerns," said R. Sivakumar, head, fixed income, Axis Asset Management Co. Ltd. Second, the Budget says MSP (minimum support price) of crops would be 50% plus production cost. This can increase crop prices, he added.
For 2018-19, government has set the fiscal deficit target at 3.3% of the gross domestic product (GDP), to accommodate higher demand for expenditure. The deficit target for FY2017-18 has also been revised to 3.5% of GDP from the earlier target of 3.2%.
Karthik Jhaveri, founder and director, Transcend Consulting, said that in the medium term, small savings rate will remain stable to very mild increase. “At the moment there is no scope for small savings rate going down further...there will be a pressure to raise it which the government will try to resist," he said.
Sivakumar said that the concern at present is that the higher MSPs could result in a spike in food inflation, which could in turn result in “RBI being more hawkish and potentially raising rates in a 1-to-2 year window."
However, a change at present is not expected on small savings rate from the government. “In the past few years, the small savings rates have come down to the extent that market yields dropped. Now I think they have converged to a large extent. So I am not sure if immediately there will be an impact. But, if yields continue to rise, there may be some changes. But at the moment, I would say the rates have now converged and there won’t be a very large change in small savings rate," Sivakumar said.
While the small savings rates may not go down further, before you make a decision on a financial product to invest in, you should compare it with the other avenues. Look at the returns that they generate and at the same time look at other parameters like taxation and liquidity. Some of the small saving schemes still fit in the portfolio of many individuals because the returns generated from them are tax free.