Interest Rate Hike for Small Savings Scheme
Present circumstances:
- In response to rising returns on government assets, the Finance Ministry last week raised the interest rates for a few small savings programmes by 20-110 basis points for the quarter spanning January to March.
- Even though the boost will protect against rising interest rates and inflation, the tiny savings rates remain below ideal levels.
Rates of small savings have risen:
- For the second consecutive quarter, there has been an uneven increase in the rates for small savings plans. While the interest rates on a 5-year recurring deposit, the Sukanya Samriddhi plan, and the public provident fund scheme have kept the same.
- For the months of January through March, rates have increased for time deposits with maturities of one, two, three, and five years as well as the senior citizens savings programme.
- The Finance Ministry raised interest rates on some of the modest savings programmes in the months of October through December by 10 to 30 basis points after holding them stable for nine consecutive quarters.
- Interest rates were slightly raised for time deposits with durations of two and three years, as well as the elderly citizens programme and the Kisan Vikas Patra.
Increasing interest rate cycle:
- In view of rising interest rates and growing inflation, it is thought that increasing the small savings rate is essential to protecting savers, particularly senior citizens.
- The ministry contends that it is crucial to strike a balance between the interests of senior citizens and those who invest their money in non-tax-favored vehicles. It also stresses the importance of keeping small savings interest rates in check because, otherwise, the government will end up paying more in interest when it borrows money from the National Small Savings Fund.
The rate tier is set:
- Interest rates for small savings plans are modified every three months to reflect changes in benchmark treasury bonds of a similar term.
- Small saving rates typically follow yields on benchmark government bonds, but during the past two years, despite changes in G-sec yields, interest rate adjustments have not quite followed yield changes.
- The reference period for small savings rates for the January-March quarter is September to November, when the yield on five-year government securities grew by almost 15 basis points.
Are the raises enough?
- Investors in small savings programmes are concerned about the real rate of return.
- When both inflation and interest rates are high, savings have a low actual rate of return.
- The retail inflation rate was over 6% for the majority of last year and only marginally fell to 5.88% in November.
- After the Reserve Bank of India raised the key policy rate by 225 basis points, the repo rate is now 6.25 percent.
- Prior to the start of the previous quarter, the majority of small savings plans earned interest rates of less than 6%.
- The RBI’s Monetary Policy Report, released on September 30, shows that the revised small savings rates were 44–77 basis points lower than the implied rates in the calculation.
Consequences for savers:
- Unlike conservative investors and those who have already retired or are about to do so, who mostly rely on small savings plans, monthly income plans, or fixed deposits, younger investors can access the equity markets through mutual funds to grow wealth.
- Despite some rate rises on some instruments being excellent news for investors, all other modest savings instruments currently yield negative real returns with the exception of PPF, Sukanya Samriddhi Yojana, and senior citizens’ savings plans.
- Even the senior citizen savings plan has a negative net profit for someone paying the highest tax rate.
- Since retail inflation is only approximately 6%, the post-tax return on the majority of small savings instruments won’t even be enough to keep up with inflation for people in the highest tax bracket.
What options do investors have?
- A decrease in inflation and interest rates will be advantageous for stocks. Those who are comfortable with stocks should look to them when it comes to investing for retirement.
- High-rated debt securities and debt mutual funds are both more tax-efficient investments for those in the highest tax bracket. Stocks are still the best investment to guard against inflation, though.
