Starting April, govt should not fool itself on small savings rate

This was a circular the government could have slept over. The finance ministry issued a circular announcing steep interest rate cuts on small savings schemes on Wednesday night. The next morning, finance minister Nirmala Sitharaman tweeted that the circular was issued by “oversight” and that interest rates stand unchanged.

Small savings interest rates aren’t aligned with other rates in the economy, despite occasional cuts administered by the Centre. While most interest rates, including those of government bonds, have fallen steeply over the past one year, those on small savings remain elevated. In 2011, a government-appointed committee had recommended a market-based formula to calculate interest rates, but the recommendation has not been adopted. The question is how long the Centre can avoid pruning these rates.

Small savings now account for a much higher proportion as a source of funding for the government, which increases its cost of borrowing. Receipts from small savings securities funded as much as 26% of the fiscal deficit in FY21, compared with just 10% five years ago.

“While this could reduce the market supply of government paper, using small savings funds is a sub-optimal option from a cost-of-funds perspective,” Rahul Bajoria, chief economist at Barclays Securities India Pvt. Ltd, said in a note after the FY22 budget.

Tarun Ramadorai, professor of financial economics at Imperial College, London, believes that such guaranteed return products are unsustainable in the long run. “In a market, interest rates can go up as well as down, and this is an important thing for people to understand,” said Ramadorai, who chaired an RBI-appointed panel on household finance in 2016-17.

To be sure, cutting nominal interest rates is tricky when inflation is playing truant in the country. And small savings schemes are used by vulnerable sections such as senior citizens. Ramadorai argues that while it is important to develop a robust social security net, it is a gap that cannot be filled by such products.

For now, the higher interest rates and tax subsidies are drawing all and sundry to the products, with some estimates suggesting that the well-to-do are the primary beneficiaries, rather than the so-called small savers.

Arvind Subramanian, the former chief economic adviser who was famous for his data-heavy economic surveys, had argued that the rich benefit from the EEE or exempt-exempt-exempt tax treatment being enjoyed under small savings schemes. “62% of individuals using the subsidies under section 80C are at the 97.3rd percentile of the income distribution—hardly ‘small’,” the economic survey of 2016 said. Also note that household liabilities have increased and not all who save are net savers. Keeping rates artificially high hurts such households as well. The real ‘oversight’ by the government is allowing the small savings schemes to grow far bigger than its remit of serving the vulnerable.