Why small savings rates won’t be cut

This marked jump in the food subsidy bill—fuelled only in part by the pandemic—should make it easier for the government to cut the interest rates on small savings schemes, which include schemes like the National Savings Certificate, Public Provident Fund, Senior Citizens Savings Scheme, Sukanya Samriddhi Yojana, etc. The reason is simple—the steep rise in the food subsidy bill is a fallout of the government’s decision to clear the Food Corporation of India’s past arrears, which used to be funded through loans from the corpus generated through the small savings schemes.

Essentially, the government is no longer compelled to keep these schemes attractive.

But despite this, the interest rates on small savings schemes, which are currently significantly higher than the interest rate on bank fixed deposits, will continue to remain higher. Before we ask why this will be the case, it is important to understand the background first.

The background

In her budget speech in February, the finance minister Nirmala Sitharaman had said: “I propose to discontinue the NSSF loan to FCI (Food Corporation of India) for food subsidy."

NSSF stands for the National Small Savings Fund. Collections under various small saving schemes, net of withdrawals during a financial year, form the source of the funds for the NSSF.

The question is why did the NSSF give loans to the Food Corporation of India? The FCI buys rice and wheat on behalf of the government directly from farmers at a minimum support price (MSP) which is set by the government.

In order to carry out this exercise, the FCI takes on working capital loans from the banks. These loans need to be repaid.

This rice and wheat is then stored in godowns and later distributed or sold through the public distribution system, popularly known as ration shops, at a very low price.

The government needs to compensate the FCI for this difference so as to ensure that it continues to be in operation and is able to buy rice and wheat directly from farmers every year.

The government does so by making an allocation in the budget under the head of food subsidy. The trouble is that over the years, this allocation has never been enough to totally compensate the FCI.

Take the case of 2020-21. The government arrears from earlier years amounted to ₹2.44 trillion in total. This is what the government owed the FCI for not having paid it in the years gone by. The question is: If the government wasn’t adequately compensating the FCI, how did it get around to repaying the loans that it had taken from banks to buy rice and wheat in the first place?

If FCI hadn’t repaid these loans on time, the banks would end up in trouble. But nothing like that has ever happened. And this is where the National Small Savings Fund came in. It loaned money to FCI, so that the latter could then repay the banks, and carry on its operations. As of 31 March 2020, the FCI owed the NSSF a sum of ₹2.55 trillion.

How did all this borrowing from one arm and lending it to another arm help the central government?

India’s Union Budget works on a cash basis, which means only when the money comes into the government’s bank account does it count as a receipt and only when it leaves the government’s bank account does it count as expenditure.

If the government repaid FCI on time, money would leave its account and would be counted as an expenditure. By getting the National Small Savings Fund to lend money to the FCI instead, the government ensured that no such thing happened and its expenditure remained under control.

And given this juggling, it was able to declare a lower fiscal deficit, which is the difference between what a government earns and what it spends, expressed as a size of the gross domestic product (GDP).

Essentially, by following cash-based accounting, the Union government was able to do this. If it had followed accrual-based of accounting, where expenditure has to be recognized as an expenditure as soon as it is incurred, whether money has left the bank account or not, the Centre would have had to declare a higher fiscal deficit—something it wasn’t perhaps comfortable with.

However, Sitharaman’s budget speech made it clear that this financial jugglery would stop and the NSSF loans to the FCI would be discontinued. This could only happen if the government cleared the arrears that it owes the FCI, which in turn would mean that the FCI repaid the National Small Savings Fund. The finance minister had said that this will happen over a period of two years—FY 2020-21 and 2021-22.

But data suggests that the Union government has already cleared the arrears in 2020-21. As economist Sreejith Balasubramanian of IDFC Mutual Fund wrote in a recent research note: “In March, from FCI accounts, it became clear (that) the government fully repaid (all) outstanding NSSF loans… So, the government’s decision to do this one-time clean-up of the food subsidy system accounted for 1.5% of GDP in the reported fiscal deficit."

This also explains why the food subsidy number ended up as high as it did, increasing from the initial allocation of ₹1.16 trillion to a final spend of ₹5.25 trillion. In FY 2021-22, the net food subsidy that the FCI expects to get from the government amounts to ₹1.59 trillion and for the first time in many years, there are no arrears.

This is good accounting policy, given that the real expenditure of the government is reflected in its accounts.

Interest rate impasse

Other than the tax benefit, the main advantage of investing in post office small savings schemes is that they offer a higher rate of interest than bank fixed deposits. This is always an incentive for the common man.

Over the last few years, interest rates in the economy have fallen across the board. Nevertheless, the interest rate on small savings schemes were still much higher than those on bank fixed deposits. Take the case of the 5-year senior citizens savings scheme, which pays an interest of 7.4% per year currently. The State Bank of India (SBI) pays an interest of 6.2% per year on a deposit of five years to senior citizens. Clearly, the interest rate on the post office scheme is significantly higher.

One reason for this lies in the fact that over the years, the government has used the NSSF to fund the FCI. As mentioned earlier, the National Small Savings Fund got money from collections under various small saving schemes, net of withdrawals, during a financial year.

The point being that the investments made into various small savings schemes that are maturing in a given year are basically paid out of the fresh investments that come in during the course of that year. Over and above this, the National Small Savings Fund has also been lending money to the FCI and a few other government institutions. What remains after this is used to fund the fiscal deficit of the government every year.

To ensure that there is enough money in the NSSF while factoring in the total amount paid out every year as withdrawals, the Union government needs to offer a higher rate of interest on these schemes. This is done so that people have some incentive to invest in these schemes rather than opting for fixed deposits in banks.

In the last few years, the fact that the National Small Savings Fund has played a significant role in funding the FCI ensured that the government was compelled to maintain the interest rate differential between small savings schemes and bank fixed deposits. This was the only way to ensure that more money kept coming into the small savings schemes, and hence NSSF, which could in turn be used to fund the FCI.

But now, with the FCI arrears being cleared, the need to use the NSSF to fund the FCI does not exist any longer. In this scenario, the government can easily cut the interest rate on small savings schemes and thus bring down the interest rate differential that prevails with bank fixed deposits—something that it hasn’t been able to do over the years.

Political fallout

When it comes to the economics of it, the government is clearly in a position to cut interest rates. But interest rates on small savings schemes are not just about economics; there is politics at play as well. Take the case of what happened earlier this year.

On 31 March, the central government had issued an office memorandum, declaring a cut in the interest rate on small savings schemes for the period April-June 2021. The interest rate on the Public Provident Fund was cut to 6.4% from 7.1%. The Senior Citizens Savings Scheme saw a higher cut from 7.4% to 6.5%.

This was in line with the broader strategy of the finance ministry and the Reserve Bank of India (RBI) to drive down interest rates to tackle the negative economic impact of the coronavirus pandemic. The idea being that once interest rates on small savings schemes went down, banks would be able to cut interest rates on fixed deposits further, which, in turn, would allow them to cut interest rates on their loans. This would lead to more people borrowing and spending, and then companies too would borrow and expand.

All this would get economic activity back on track. At least that’s how it was supposed to work in theory.

But the interest rate cut was withdrawn the very next day. On 1 April, the Union finance minister Nirmala Sitharaman tweeted: “Interest rates of small savings schemes… shall continue to be at the rates which existed in the last quarter of 2020-2021."

The interest rate cut on small savings schemes would have happened right before the state assembly elections, primarily in Tamil Nadu and West Bengal, but more importantly in West Bengal, where the Bharatiya Janata Party (BJP), was trying to establish itself.

It turns out that West Bengal is the largest contributor to the small savings schemes. Data from the 2017-18 annual report published by the National Savings Institute suggests that West Bengal is the number one gross contributor to the post office small savings schemes.

In 2017-18, West Bengal contributed ₹89,992 crore, or 15.1% of the gross contributions made. This data might be a few years old, but this is a long-term trend and can’t change dramatically every year.

Given this, cutting interest rates on these schemes just before the state assembly elections would have been bad politics to the say the least.

It is also worth remembering that elections are scheduled in Uttar Pradesh and Gujarat early next year. These are both politically very important states for the BJP. It is also worth mentioning here that when it comes to gross collections made under the small savings schemes, Uttar Pradesh comes in next after West Bengal. In 2017-18, a sum of ₹69,661 crore or 11.7% of the overall contribution, came from the state. Gujarat was fourth on the list, with an overall contribution of ₹48,645 crore (8.2% of the total).

If the West Bengal example is anything to go by, it is highly unlikely that the central government would majorly tinker with the interest rate on the savings schemes in the months ahead, even though it is in a position to do so. Ultimately, the politics of the day won’t allow it to do so.

Vivek Kaul is the author of Bad Money.