Why govt should not have cut small savings rates

Dateline New Delhi

From April 1, interest rates on popular small saving schemes such as Kisan Vikas Patra, National Savings Certificate and post office recurring deposit schemes will come down as per government’s recent decision. The interest rates will be reduced by a quarter percentage point.

But they will remain unchanged on schemes such as Sukanya Samriddhi Yojana, Senior Citizen Savings Scheme, Monthly Income Scheme etc.  Rates on five-year term deposit, five-year National Saving Certificates were also left untouched.

The government has also decided to review interest rates on those small savings schemes which are linked to the interest rates of government securities every three months. They are currently reviewed on yearly basis. While taking the decision to lower the rates on these schemes, the government said it will help the lower income and the salaried class. But, considering that small savings schemes are the backbone of small investors, will it really help and, in what way?

Indians are among the best savers in the world with savings rate nearly 30% of the GDP. The Indian salaried class persons saves throughout their working life to secure their own future and that of their progenies because the government does not provide any social security as opposed to many other countries. The parents save so much that their offspring hardly require any education loan. The traditional lavish weddings are mostly financed by household savings.

The habit of savings is so ingrained in our culture that even the retirees save.  And, despite facing constraints of a formal banking system, the poor save a lot. The household sector contributes more than two-third of the total national savings. The public and corporate sectors together are responsible for the remaining one-third.

In this scenario, incentivising household savings and promoting them is best suited to the people as well as the government, which can aggressively invest these savings in infrastructure building in the country. The financial inclusion policy of the government which seeks to provide  formal saving instrument such as banking to every household has been hailed by many  as the best in the world for inclusive economic growth.

Studies have suggested that in the absence of formal, safer and incentivising savings products, households in India turn to informal channels and physical assets such as gold and land while in China, the household savings are invested in creating infrastructure.
At a time when financial inclusion is at a nascent stage, cutting interest rates on small savings will only make households with lower incomes go back to the older methods of saving. The question arises - whether the government should have waited for a while before taking such a step?

At present, interest rates on small savings schemes range from 8.4 to 9.3%. After a quarter percentage point cut, they will range from 8.15 cent to 9.05%. The interest rates on fixed deposits on banks is in the range of 7.25 and 7.5%.

Pressure from banks

What prompted the government to go for the unpopular decision was pressure from the banks which said that their deposits were coming under stress because of  higher rates on small savings. In other words, they said that the government’s saving schemes were  snatching their customers away leaving them with a little money and limiting their capacity to lend on cheaper rates. This, they said, was also curbing their ability to transmit rate cuts by the Reserve Bank of India. The government steps have come as a gift to them. Or, at least it is perceived so.

But, a closer look on cutting the rates suggests that it does not help much in increasing the commercial banks’ deposit base nor does it open all routes for rate cut transmission. Here is why: Even after the lowering of the interest rates on small savings, the rates on post office deposits and KVP are still higher than deposits of commercial banks.

Besides, the schemes on which the interest rates will be cut are less than one third of the total deposits with the National Saving Schemes. In other words, those who have been saving in these products will continue to do so unless the government lowers the rate further to align them with the rates of bank deposits.

The government, with the sole motive of promoting small savings had re-introduced KVP in 2014. The scheme had been discontinued after a committee under former RBI deputy governor Shyamla Gopinath recommended that it was liable for misuse. Analysts had questioned the motive behind re-introducing the KVP. They are now questioning the seriousness of the government behind launching the KVP and reducing interest rates on them.

Households savings are not picking up or have been drastically reduced in the past not because there are not enough products for savers but because prices of essential commodities have gone up so much that their ability to save has been eroded. Secondly, the existing saving products are unattractive unlike gold and real estate.

To ramp up savings rates and household savings, the government should take steps to check rising prices, make financial products more attractive to wean away people from gold and leave interest rates on all kinds of savings untouched till the government’s savings increase to a level closer to that of household savings.

An estimated Rs 31 lakh crore is required to provide uninterrupted power supply to homes and industries and improve road, transport, telecom and other urban facilities in the next five years. This means Rs 6 lakh every year. The households savings contribute substantially towards it even today.