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Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Small savings need clear incentives

The past three decades have shown a good spread of income at various levels, and concentration of wealth seems to be gradually penetrating downward

The Indian economy is now recognized as one of the fastest growing economies in the world. The past three decades have shown a good spread of income at various levels, and concentration of wealth seems to be gradually penetrating downward. This results in more households with higher incomes than they had earlier, and higher consumption arising out of the aspiration of middle-class households and also savings and forced savings (equated monthly instalments and loans, for instance). For the development of the economy, and infrastructure, there is a need for substantial amount of savings.

It is increasingly being recognised that the funding of the economy will have to be mobilised from domestic savings. Currency risk and inflation will continue to pressurise the economy from borrowing too much from external markets. Therefore, household savings, particularly small savings, need to be encouraged. The duration of savings will also play a significant role. There has to be clarity in the fiscal systems to encourage small savings as well as long-term ones.

In this backdrop, let us examine the options available to a small saver. At the basic level, she has bank savings accounts and the postal services. Bank savings mobilisation has, in the past two decades, been one of the highest in terms of its share of total savings mobilisation. The entire banking system has standard deposit products and the interest rate is normally lesser compared to other instruments. The saving rates are linked to the lending rates with a sizable spread of 8-10%. Added to this, there isn’t any fiscal incentive worth mentioning for bank deposits.

Next in line are products for the medium term (3–6 years). These account for a smaller percentage of total savings. This could perhaps be due to volatility in the interest rate structure for time deposits, but largely due to non-awareness. Among the products available, sovereign mobilised savings, National Savings Certificates and postal deposit products have fiscal benefits in the form of tax concessions. There are also mutual funds with various options, including equity, debt, and hybrid options with open-ended or fixed duration tenures. These, too, come with fiscal incentives. While the pricing mechanism of mutual funds is transparent, for small savings instruments of the postal services, it is based on the government’s borrowing programme and tends to be unscientific and beyond the understanding of a small saver.

At the upper most end of the spectrum of duration, we have pension products from public and private institutions. Public Provident Fund (PPF), National Pension System (NPS) and Employees’ Provident Fund (EPF) are long-term saving plans and come with attractive fiscal incentives. But the pricing of such instruments (yield or interest rate), other than for NPS, is opaque. So, do these instruments provide the saver protection from inflation, and real income? While NPS might help you do this if you choose the option that invests in equity as well, the other two don’t provide the necessary shield against inflation and falling rupee. The major factors that contribute to this could be put in categories. The first is the clarity, or lack of it, from the government in designing fiscal incentives for savings. The second factor that contributes to this inconsistency in the rate structure is the inefficiency of institutions that mobilise savings. Bank savings have to be priced based on lending rates. The banking system has to price default and inefficiency to the borrowers. However, the tendency is to push the cost of inefficiency to the saver.

Then again, the interest rates for PPF and EPF are determined on the basis of macro-economic data, which may perhaps be unreliable. For the saver, therefore, it is difficult to predict the direction in which rates will move.

It is important for the government to evolve a sound fiscal policy including incentive packages or disincentives to channelise savings in financial instruments to encourage long-term small savings. The asset allocation of these funds also needs to be re-examined. This is particularly so in the case of life and pension products.

If the real yield of the small saver is not protected, then we may have a serious issue on hand. This is aggravated by the fact that we do not have old-age security provided by the sovereign and also a high order of financial illiteracy. And lastly, the interest rate determination should be market driven and transparent.

Views expressed are personal.

Ashvin Parekh is managing partner, Ashvin Parekh Advisory Services LLP.

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