Times of India’s Edit Page team comprises senior journalists with wide-ranging interests who debate and opine on the news and issues of the day.
In less than 24 hours, government reversed Tuesday evening’s decision to reduce the interest rate on small savings schemes. The episode highlights the flaws of the current approach to setting interest rates. These schemes are administered by government and their interest rate is linked to rates on comparable government securities, or GSecs. Since April 2016, government is supposed to reset these rates every three months. However, resets have been haphazard, rendering the formula of setting interest rates meaningless. There’s a reason for it.
Interest rates on GSecs are not truly market driven, even if these bonds are traded. RBI significantly influences these rates, depending on its monetary policy approach. First, the monetary policy committee sets a policy interest rate. This is backed by RBI using an array of instruments to push GSec yields to levels that meet its aims. Over the last two years, as economic growth has been prioritised over inflation, interest rates have been pushed lower. RBI and banks may crib that inflexible small savings rates distort monetary policy signals but governments face a different set of constraints.
Small savings schemes have for long been of great benefit to the Centre and states. Their popularity also shows how important they are as a risk-free long-term savings option for people. Interest rates on these schemes do need to be linked to monetary policy, but the current formula is suboptimal. We are in midst of a spell of financial repression to boost growth and help government borrowing. But if savers are taken for granted, there will be higher risks of financial instability. The formula needs to be reworked to cushion savers from the fallout of financial repression. That’s better than the seeming arbitrariness in reset of interest rates. Yesterday’s rollback just acknowledges the need to change the formula.
This piece appeared as an editorial opinion in the print edition of The Times of India.