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As we approach June, there is trepidation among fixed-income earners in India, particularly senior citizens, as the interest rates on small savings will come up for review. Late March, the government had announced an across-the-board reduction in interest rates of around 90 basis points, but then withdrew the circular, ostensibly on the realization that state elections were around the corner. Now with those elections behind us, this review will take place next month for sure.

Let us understand the ethos behind the small savings scheme. Small savings were established way back in 1959 with the aim of providing avenues for saving to everyone through post offices. It was a kind of affirmative-action programme for lower-income groups, which had little access to banking services. There are around 150,000 post offices in the country, 90% of them in rural areas. As post offices provided last-mile connectivity to people, bank deposit schemes were replicated with them. Over time, they were encouraged to offer fixed and easy long-term saving options through schemes like the National Savings Certificate (NSC), Kisan Vikas Patra and Indira Vikas Patra. More recently, the Senior Citizen Savings Scheme (SCSS) was introduced to provide some comfort. In between, a Public Provident Fund (PPF) was established to help citizens provide for their future, aimed especially at those who were not in the organized sector and in need of social security. It was later opened up to all.

The outstanding balances, as of February 2020, were around 10.4 trillion, which compares quite unfavourably with bank deposits that stand at around 150 trillion. Deposits are around 68% of total small savings, while 24% are in certificates and the balance 8% in PPF accounts. Of the deposits, around 22% are in savings deposits and a similar proportion in time deposits; the Monthly Income Scheme has a share of 28-30%; nearly 10% are in senior citizen deposits, and 16% in recurring deposits. As can be gauged, these schemes cater to lower-income groups predominantly, and offer senior citizens a fallback for income.

The money collected in these schemes is lent to the central and state governments, usually at a rate 50 basis points higher than the cost of small savings. These schemes are open-ended, with limits only on PPF. In 2019-20, the market-borrowing cost of fresh issues by the Centre was 6.9%; the interest rate on NSC was 6.8% as of 1 April 2020 (when it was last revised based on the movement in yields in previous quarters). In 2020-21, the government’s cost of borrowing was around 5.8%. With the anchor rate for small savings at 6.8%, the government will have to pay around 7.3%, which is too high. Thus the argument to correct their rates.

There is another argument made by bankers, that higher small-savings rates have come in the way of their ability to lower deposit rates. This argument is weak; given the class of people who invest in small savings, substitution does not take place. In fact, even today within the banking system, higher deposit rates are offered by Yes Bank, IndusInd Bank, IDFC First Bank, etc, relative to other commercial banks. If the bankers’ reasoning of substitution had merit, one would have seen deposits move to these banks where returns are at least 100 basis points higher than those offered by others. Therefore, the argument is disingenuous.

Be that as it may, the rationale offered is in conflict with the ethos of small savings. It is meant to provide sustenance to vulnerable groups; presently, the SCSS yields 7.4%. If the rate on NSC, which acts as an anchor, is reduced to 5.9% (from 6.8% presently), then a proportional cut in SCSS will bring its rate down to 6.5%, eroding the income of this segment by 700 crore. This defeats the purpose of having such a scheme for seniors. If small saving schemes don’t help their intended beneficiaries, they might as well be done away with, as post offices have lost their relevance as mediums of communication, and India Post is now a payments bank.

Let us look at the cost the government would have to incur by leaving things be as they are. Total outstanding savings are around 10.4 trillion, with a net increase of around 1.15 trillion annually. Not changing the small savings rate this year by, say, 100 basis points, would imply a cost of around 1,150 crore, which can be treated as a subsidy and incorporated in the Union budget. In fact, this will add in a marginal way to consumption, as this money is not saved, typically, but actually spent by individuals. Hence, it can serve as a minor contribution to the spending cycle. By absorbing it in the budget, the government can help this class and simultaneously lower its own cost of borrowing by drawing from this fund at, say, 6.3-6.4%, which would have been the cost if the benchmark rate fell to 5.8-5.9%.

There is a strong argument to do so if one looks at the way government-security rates have moved over the past year. Monetary intervention has worked hard to lower the cost of borrowing for banks. This, together with large flows of funds to the banking system—through long-term as well as targeted long-term repo operations, and open market operations—and ‘Operation Twist’, has kept interest rates down. The 100 basis points fall in rates in 2020-21 meant a savings of 12,800 crore (1% of 12.8 trillion of borrowings). Even today, the bond market is not willing to accept lower yields, but Mint Street has persisted with efforts to keep 10-year government paper at 6%. Hence, if the government subsidizes small savings, the actual cost can be adjusted against this large gain. This is something worth considering.

Madan Sabnavis is chief economist, Care Ratings, and author of ‘Hits & Misses: The Indian Banking Story’ .These are the author’s personal views.

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