The government is contemplating reducing interest rates on small saving schemes for the Q3 2021. A cut in the savings rates is expected to negatively impact households, especially considering the current inflation spike, warn economists.
Background
Small savings rates experienced a decrease between 0.5% and 1.4% on various instruments in April 2020. This adjustment brought down the Public Provident Funds (PPF) rate from 7.9% to 7.1%.
In the Q1 2021-22 (April-June), the government planned another reduction in interest rates. However, this decision was reversed and termed as an “oversight”.
About Small Saving Schemes/Instruments
In India, small saving schemes are a significant source of household savings, consisting of 12 instruments. Depositors earn a guaranteed interest on their investment. All collections from these instruments contribute to the National Small Savings Fund (NSSF).
After the Covid-19 pandemic and subsequent government deficit, small savings have become a crucial borrowing source.
Classification of Small Saving Instruments
Small saving instruments can be grouped into three categories: Postal Deposits including savings account, recurring deposits, time deposits of varying maturities and monthly income scheme; Savings Certificates including National Small Savings Certificate (NSC) and Kisan Vikas Patra (KVP); and Social Security Schemes like Sukanya Samriddhi Scheme, Public Provident Fund (PPF) and Senior Citizens‘ Savings Scheme (SCSS).
Determination of Interest Rates
Every quarter, interest rates on small saving schemes are revised based on changes in benchmark government bonds of similar maturity. The Ministry of Finance conducts periodic reviews. Over the past year, government bond yields varied from 5.7% to 6.2%, providing the government an opportunity to cut the small savings scheme rates.
Impact of Rate Cut
The central government uses the small savings fund for deficit financing. Lower rates would decrease the cost of deficit management. A cut in rates might indicate a strategy by the government to encourage consumer spending and stimulate the economy.
Disadvantages of a Rate Cut
Rate cuts could negatively affect investors, specifically the middle class and senior citizens. Notably, household savings have already been declining over two successive quarters even prior to the second Covid-19 wave. As a fall out, banks may further rationalise fixed deposit rates, decreasing returns.
Rate of Return, Inflation and its Effect
The rate of return is the expected amount earned from investments like savings accounts, mutual funds or bonds. The real rate of return, accounting for inflation, is calculated by subtracting the inflation rate from the return on investment.
Inflation undermines an investor’s annual rate of return. When inflation surpasses the rate of return, investing money results in a loss due to reduced purchasing power.
Inflation denotes the rise in prices of common goods and services, impacting the purchasing power of a currency unit.
