They have an invaluable role as a provider of social security net, which ought not to be downplayed

Small savings schemes — post office savings bank account, senior citizens' savings scheme, National Savings Certificate, public provident fund (PPF) and others — are sought to be made more popular.

In accepting most of the recommendations of an expert group, headed by RBI Deputy Governor Shyamala Gopinath, the government proposes to give a market orientation to these schemes. Basically that involves linking interest rate on these schemes to some well-known benchmarks such as yield from government securities of comparable maturities.

The change has become necessary because the administered interest rates applicable to these schemes have lagged behind the deposit interest rates offered by the banking system. Though similar to bank deposits in their structure, their interest rates are not set on commercial considerations. Small savings collections have been declining recently.

The difference has become particularly pronounced after banks were given the freedom to fix their own rates on all their deposit schemes. The last bastion of administered interest rates in banks fell recently with the RBI freeing the savings bank deposit rates. In contrast, the interest rate on post office savings bank will continue to be administered. They will, however, pay 4 per cent as against 3.5 per cent earlier. (This move has its basis in the committee's recommendations that wanted the post office savings bank to match commercial banks. The committee was constituted more than a year ago. Since then, banks have been allowed to fix their own rates, including on savings bank).

Panel's approach

The committee's approach to small savings has, however, emanated from the angle of public finance, not just the private finance problems of savers.

Not surprising because it was set up at the instance of the 13th Finance Commission.

Apart from being asked to comprehensively review the various small savings schemes in operation with a view to making them more flexible and market-oriented, the committee was asked to look at the entire mechanism of the National Small Savings Fund (NSSF), especially its role in financing the Centre and the States.

While discussing the relative popularity of the small savings schemes and bank deposits, one is apt to forget that small savings schemes have a crucial role in public finance. Forming a significant part of the internal liabilities of the Central government, small savings are contractual savings of the public, which are not part of the Consolidated Fund of India.

Net accretions through small savings finance a part of the fiscal deficit. This has been coming down. The government recently announced an extra borrowing of Rs.53,000 crore from the market to make up for the shortfall in small savings.

With the implementation of the key recommendations of the committee, the process of fixing interest rates on small savings schemes will become transparent. That should help in a more cost-effective management of public finances at the Centre and the States. But will the move revive popular interest in these schemes?

It would be naïve to assume that a mere tinkering with the interest rates is enough to check the falling collections under small savings. Even more basically, small savings schemes, now being referred to cover a gamut of schemes ranging from the highly liquid post office SB deposits to the long dated Public Provident Fund (PPF), which is essentially a retirement option, confer outstanding tax advantages. Obviously, there cannot be a single point solution by way of higher interest rates to entice savers under all categories.

That is why the recent changes in the public provident fund (PPF) make it particularly attractive. A tax payer can invest up to Rs.1 lakh (Rs.70,000 now) and claim tax benefits under Sec. 80 C of the Income-tax Act. Besides, because of the linkage to market rates, the PPF will now pay 8.6 per cent, up from 8 per cent. In all these calculations, however, it is assumed that the interest rates will hold steady, at least for a reasonable period.

One important move here is to reset the interest rate on the small savings schemes on an annual basis. Too frequent changes will unsettle savers. At the same time, interest rates will have to reflect markets rates.

The postal time deposits and the Monthly Income Scheme (MIS) have many features of bank fixed deposits. However, the bonus (of 5 per cent) the MIS offered on maturity is being abolished and the interest rates on time deposits and the MIS are being realigned with market interest rates. There are a large number of schemes that come under the category of small savings. These serve the thrift needs of various sections of the population. Realising this, the committee has recommended just one scheme — the Kisan Vikas Patra — for closure. This scheme, however, accounts for a large share (more than 25 per cent) of small savings.

The only reason for its closure is that it is in the nature of a bearer bond and hence prone to be used for tax evasion. Small savings should complement bank deposit schemes. They also have an invaluable role as a provider of social security net, which ought not to be downplayed.