WHY AREN’T INTEREST RATES ON SMALL SAVINGS SCHEMES RISING?

25 Jul 2024 , 02:48 PM

On June 28, 2024, the Indian government announced that the rates of interest on its various small savings schemes were being left unchanged for July-September 2024. This was the second quarter in a row that these interest rates were not being increased after the government had kept raising them for six consecutive quarters, with the last being January-March 2024.

What are small savings schemes

Small savings schemes are the government’s way to ensure that citizens set aside some money from their incomes on a regular basis for their future. These savings are at a fixed rate of interest and as such are especially beneficial to small savers who can’t afford to take any risk with their savings by investing them in the stock market.

At the same time, to ensure that they are an attractive proposition for individuals, the government offers relatively higher rates of interest on some of these schemes compared to what is available in the market. For instance, the Sukanya Samriddhi Account Scheme currently offers a rate of interest as high as 8.2 per cent. This is well above nearly all fixed deposit interest rates offered by banks.

Some other types of small savings schemes offered by the government include Senior Citizen Savings Scheme, Monthly Income Account scheme, National Savings Certificate, Public Provident Fund, and Kisan Vikas Patra, among others.

Crucially, these schemes offer a tax benefit, which is particularly useful for those individuals in the lower income categories.

Why small savings schemes are important

Apart from just incentivising citizens to set aside some money for their future and create a financial safety net, the government also uses the small savings it collects to finance its fiscal deficit, or the difference between its income and expenditure.

For instance, in the Interim Budget for 2024-25, the Indian government has estimated that its fiscal deficit will Rs 16.85 lakh crore. It has said that it will finance a majority of this – more than Rs 12 lakh crore – by issuing bonds that will be purchased by banks and other financial institutions.

However, the government also expects to finance Rs 4.66 lakh crore of its fiscal deficit through small savings collections. This is a sizeable number. So, if the public invests more money in these schemes than the government expects, the government can actually reduce the amount of bonds it issues. This can help reduce the overall level of interest rates in the economy. But if small savings collections end up being lower than expected, then the government has to make up the shortfall through other means.

The current rate of interest on these schemes

As per the June 28, 2024 announcement by the Indian government, the current rate of interest on small savings schemes is as follows:

Savings deposit: 4.0 per cent

One-year time deposit: 6.9 per cent

Two-year time deposit: 7.0 per cent

Three-year time deposit: 7.1 per cent

Five-year time deposit: 7.5 per cent

Five-year recurring deposit: 6.7 per cent

Senior Citizen Savings Scheme: 8.2 per cent

Monthly Income Account: 7.4 per cent

National Savings Certificate: 7.7 per cent

Public Provident Fund Scheme: 7.1 per cent

Kisan Vikas Patra: 7.5 per cent

Sukanya Samriddhi Account Scheme: 8.2 per cent

How are interest rates on small savings schemes decided?

Given the importance of small savings schemes as a financial safety net of sorts to small savers as well as a way for the government to finance its fiscal deficit, the manner in which interest rates on these schemes are decided is vital.

Since 2016-17, the government has been announcing these interest rates for every upcoming quarterly period. Until then, a fixed number was announced for the entire year. Further, since 2012-13, these interest rates have been decided on the basis of a formula instead of any arbitrary level, making it a more transparent process.

As per the formula, interest rates on small savings schemes are linked to the market yields on the government’s securities and are 0-100 basis points higher than the yield of the securities of a similar maturity in the reference period. For example, if the market yield on the government’s five-year bond is 8 per cent in the reference period, then the rate of interest on the five-year time deposit should be 8.25 per cent as the ‘spread’ per the formula is 25 basis point for the five-year time deposit.

However, it has been seen on many occasions in the past few years that the small savings interest rates have not moved in tandem with market yields on government securities. In September 2022, the Reserve Bank of India said in its Monetary Policy Report that the interest rates on these schemes were 44-77 basis points below the rates suggested by the formula. At other times, the rates have been higher than what they should be as per the formula.

Will interest rates on small savings schemes rise in the future?

Here is how the interest rate on small savings schemes have moved in recent years: after the latest announcement, they have now been left unchanged for two consecutive quarters. Prior to that, they were increased for six quarters in a row, starting October-December 2022. And before that, these interest rates were not changed for nine straight quarters.

Assuming these interest rates are changed as per the formula, it is possible that they may even be reduced in the coming months. Why? Because market yields on government securities could decrease. This is because increased demand for the government’s bonds leads to lower yields. And demand for government bonds is expected to increase in 2024-25 after their inclusion in global bond indices.

Starting June 28, 2024, Indian government bonds became part of JPMorgan’s bond indices. These indices inform and guide international investors on the movements in government debt prices in various countries. According to experts, the inclusion of India on these indices could lead to around $25 billion worth of foreign inflows into the Indian government bonds over the next 10 months. This could lead to lower bond yields and consequently, a decline in small savings interest rates.

FAQs

Q: Why haven’t interest rates on small savings schemes increased recently?

A: The Indian government has kept interest rates unchanged to align with fiscal policies and market trends.

Q: What are small savings schemes?

A: Small savings schemes are government programs that encourage citizens to save regularly at fixed interest rates, offering benefits like tax exemptions and higher interest rates compared to market alternatives.

Q: How are interest rates on small savings schemes determined?

A: Interest rates are linked to market yields on government securities, set 0-100 basis points higher, and reviewed quarterly.

Q: What should I do if small savings rates decrease?

A: Diversify your investments and consult with a financial advisor to explore alternative saving options that offer competitive returns.

Q: How do small savings schemes benefit the government?

These schemes help finance the government’s fiscal deficit, reducing the need for bond issuance and potentially lowering overall interest rates.