On March 27 the government increased the interest rates on a range of small savings schemes .While the interest rate on post office savings bank accounts has been left untouched — it remains at 4 per cent — there has been an upward revision in the interest rates on a number of other schemes, including the post-office operated monthly income scheme and the public provident fund (PPF). The increase ranges from 0.2 percentage points to 0.5 percentage points, which can hardly be considered significant.
However, the implications are several. On the one hand, there is a recognition of the heterogeneous nature of the different schemes under the broad heading small savings .An interest rate that is considered appropriate for time deposits need not be relevant for either the Monthly Income Scheme (MIS) or the PPF. Yet, public perception of small savings being what they are, the uneven nature of interest rate hike might confuse prospective savers.
An even far bigger issue is to examine the rationale of the interest rate increases. In November last year, following the acceptance of the key recommendations of an expert group, the government decided to give a” market orientation” to the schemes. Basically that has meant linking the interest rates on small savings schemes to some well-known benchmarks such as the yield from government securities of comparable maturities. However, the interest on small savings schemes is still administered. The government will continue to fix the rates (taking into account the movements in yields on government securities).
Even the revised rates lag behind comparable deposit rates offered by banks. That is perhaps inevitable. Banks have the freedom to fix interest rates on both deposits and loans .Since commercial considerations, rather than government directives, determine their interest rates, banks respond quickly to interest rate changes brought about by monetary policy. Moreover, each bank determines its own interest rate structure based on its balance sheet strengths and commercial considerations. In practice, the deposit as well lending rates of all banks tend to converge within a narrow range.
One exception has been the savings bank deposit rates, which were the last to be deregulated. Large public sector banks continue to offer 4 per cent. It matches the post office savings bank. However, some new private banks have been offering as high as 7 per cent. In term deposits, the interest differential among banks is not that significant but it will be useful to recognise that banks do compete with each other on the basis of price (interest rates) even though it is the non-price competition — customer service, ambience, technology — that would appear to be the key determinant in attracting customers.
The last point is very useful to explain why it is inappropriate to compare commercial banks with the small savings schemes. The core strengths of small savings schemes are (1) that they can be operated through post offices, which have a wide network; (2) the tax advantages that they confer on investors in certain cases. The PPF scheme, for instance, is extremely popular with tax payers because of the concessions it confers under Section 80 C of the Income-tax Act, although its yield, at 8.8 per cent, is by no means inconsiderable.
Shorn off those tax concessions, the post office savings schemes look ordinary. The network advantage that the post office has had is being blunted as banks spread out on their own as well as through various innovative means such as the business correspondent model. Besides, banks have the technology edge, and even the most staid public sector bank has managed to create an ambience which is hard to find in most post offices. In the financial year just gone by, gross small savings collections at Rs.5.10-lakh crore are expected to be considerably below the Rs.8.64-lakh crore that was originally budgeted for.
A comparison with banking system is, therefore, misleading. It is highly unlikely that the modest increases in the small savings interest rates will spur deposit collections. Realising the likely shortfall in the National Small Savings Fund, the government stepped up its borrowing by Rs.53,000 crore last year. For fiscal 2012-13, the government has scaled down its estimate to Rs.5.69-lakh crore, a mere 11 per cent increase over previous year's revised estimate.
Though much less known, small savings schemes have a very important 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. Given the ongoing debate over fiscal deficit and fiscal consolidation, it is obvious that small savings schemes have a very large role to play. Whether their new market orientation is sufficient to reverse the trend of falling collections is an entirely different matter.