SynopsisExperts are divided on whether rate cuts are necessary or not.
The government slashed small savings interest rates on 31 March, only to withdraw the order the next day. ET Wealth speaks to experts to get their views on this issue.
Ajit Menon, CEO, PGIM India AMC: No
The argument to dereregulate small savings rates arises primarily from the concern that higher rates can impede rate transmission. Banks have flagged this as a reason for sluggish deposit growth and inability to lower lending rates. However, the difference in deposits between the two—Rs 10.46 lakh crore in small savings vs Rs 142 lakh crore in bank deposits, negates this argument.
Small savings schemes were created to offer a viable long term alternative to savers and for the government to raise capital for its spending needs. Most Indians still have no viable alternative to channel their retirement savings. Financial inclusion is still low, with close to 190 million Indians still not having a bank account.
“Most still have no alternative to channel retirement savings.”
— Ajit Menon
Financialisation of savings is a slow, multi-year theme that was resurrected in 2014 with RBI incentivising savers by offering a “positive real return” over consumer inflation. With the government having chosen to continue with the CPI band of 4% +/- 2%,the PPF interest of 7.1% offers just over 1% over the higher end of the inflation band. Lowering rates on small savings runs the risk of nudging retail money into riskier asset classes. The hard work of the last few years can come undone if rates are lowered too quickly. Inflation for many retirees with medical conditions for example would be much higher. A sharp drop in returns of these products will have a significant impact on this segment.
As viable and low risk alternatives such as direct investment in government securities and NPS are developed, the present spread on small savings can be slowly lowered. In the meantime, small savings will provide savers with a low-risk inflation beating option and help the government meet its budget deficits. Actions that increase participation in formal channels with products designed to attract savings from the young and protect the vulnerable is an important balance to strike.
A Balasubrahmanian, CEO, Birla Sunlife AMC: Yes
There is merit in revisiting these rates so that they are aligned to prevailing interest rates across the economy. Instead of keeping interest rates static at higher levels, these can be periodically changed as per underlying dynamics in the market rate. There should also be the provision of increasing small savings rates when interest rates inch upward.
The rationale of keeping rates high is that most of these schemes are used by savers who don’t have access or understanding of other avenues. Given the nature and investors of such savings, there is merit in marking up the prevailing interest rate trend. Once such direction is set, it can be reviewed at periodical intervals, say every two years.
“There is room for rationalising rates, but with tweaks.”
— A Balasubrahmanian
For PPF, the case for rationalisation of rates is stronger, since PPF is largely used as a tax saving mechanism. Most subscribers will be salaried with a good understanding about other tools available in the market. For this segment, ELSS could be a better option.
There is room for rationalising rates, but with tweaks that can be dynamically managed based on market environment. It can be a win-win scenario for all.
G Pradeepkumar, CEO, Union AMC: No
I believe that the small saving rates should not be reduced from current levels under the present circumstances. Yes, agree that there has been an overall reduction in interest rates in the economy. However, the risk of inflation remains. Market rates are down due to abundant liquidity and not because inflation has come down. Due to high liquidity, inflation may rise further. Let us not get too complacent with rates.
“Reducing rates can damage retirement plans of millions.”
— G Pradeepkumar
One also has to look at the socio-economic impact of lowering rates. In case the interest rate on small savings is reduced further, savers would be compelled to look for other high yielding instruments, many of which come with high risk which a common man may not be able to understand or manage. Any action that forces ordinary people to take an unacceptable level of risk should be avoided.
Since India doesn’t have a social security net, the negative impact of interest rate reduction in long term products like PPF will be tremendous. There are many who use PPF as their primary saving instrument. Reducing the interest rate below a certain level can cause irreparable damage to the retirement plans of millions and create a huge social and economic problem.
Nilesh Shah, MD, Kotak AMC: Yes
Savers want higher interest rates. Borrowers want lower interest rates. Senior citizens want higher interest rates for a retired life. Borrowers want lower interest rates for successful business. However, there is no free lunch. If a nation favours borrowers, savings will get disincentivised. If a nation favours savers over investment, growth will suffer. When a nation pays higher interest rate to a group of savers they are delighted by the apparent higher return but they don’t realise the cost which they have to pay in the form of higher inflation (higher interest rate adversely affects investment and capacity creation restricting supply) or higher unemployment for their next generation (lower investment impacts job creation).
Nature has taught us that excess of anything has more harmful impact than benefit. Ayurveda believes that a person will be in a good health as long as three attributes— Vat, Pitt and Kaph are in equilibrium in the body. Like balance/equilibrium is key to maintaining harmony in nature, there should be balance between the need of a saver and a borrower.
“We need balance between the needs of a saver and a borrower.”
— Nilesh Shah
The market should determine the equilibrium between borrower and saver. Small savings interest rate should be linked to market rates to create fairness between borrowers and savers. Deep and vibrant capital market is a prerequisite for creating such equilibrium.
Market determined rates will be win-win for borrowers, savers and economy in terms of lower inflation and higher growth. We also have to take care of the vulnerable section of society. Deserving senior citizens and other saver groups can be offered higher than market rates in a targeted manner. However, the subsidy for such higher rates should be funded out of the government budget rather than burdening the borrower. Care should be taken to ensure that such benefits are not usurped by undeserving savers.