Should small savings be market-linked?

Come April, the rates on a horde of small saving instruments, including the NSC, PPF and senior citizens savings scheme will become market-linked. Anand Kalyanaraman spoke to a few people to get their reactions on the move

‘Investment becomes risky’

Kannur-based 68-year-old KTP Divakaran Namboodhiri, a former administrative officer with LIC, gets pension and invests in PPF and a few bank fixed deposits. Namboodhiri was not aware of the proposed change to the small savings schemes. When told, he felt that the government had proposed the change before the Budget to shield the Budget from criticism. “Foul play by the government,” he remarked lightly. On a more serious note, he added, “So, the risk factor increases. When market rates come down, the rates also follow suit.” Clearly not pleased, he said, “I want a secure investment — that is why I am investing in PPF. If the interest rate fluctuates according to the market rate on a quarterly basis, then it is risky business.”

Acknowledging that rates could increase too, he still is against the move. Namboodhiri does not buy the government’s logic that interest on small savings schemes should not enjoy an advantage over bank fixed deposits. He thinks the government wants to divert people’s investments from post office schemes to bank deposits; so, it is changing the interest rate calculations.

‘The calculation will be complicated’

Veteran investor Chandrakant D Solanki from Chennai gave the proposed move a thumbs-down. The 63-year old Solanki, formerly Senior Cameraman with Doordarshan and now Trainer Broadcast at the Asian College of Journalism, Chennai, feels that most subscribers of the post office savings schemes are from small towns and villages, and that these schemes are for the welfare of the general public. The government should not make the rates market-linked since these schemes also help many senior citizens, he feels.

Solanki raises the point of complicated calculations under the new rules, which could harm acceptance of the schemes. He says, “Most people are not educated enough to figure out whether the interest rate will go up or down. Also, if you start changing rates every quarter, how will a small investor calculate how much he will get on maturity? This is only going to kill the scheme.” He also feels that post offices may not be equipped enough to handle the complications arising from frequent ups and downs in rates. Besides, he says, there is confusion on how exactly the returns will be calculated — will the return on an investment change every quarter or will the revision in rates be applicable only to new investments made in the quarter? The savvy investor that he is, Solanki moved quickly to put money into the NSC. He says, “Once I knew that the government is going to reduce rates, I invested a lumpsum in NSC before the rate goes down. That half or 1 per cent matters to me.”

All said, Solanki urges the government to continue with the present practice. “Let the rates be reset only once in a year,” he says. He adds, “At the time of the Budget, let them say that these will be the rates for small savings. They could be less, but they should be fixed. Even educated persons will get confused with the fluctuations.”

‘It’s inevitable — this trend will continue’

Thirty-four-year-old Samir Kumar, partner at research firm Profound Financial at Delhi, has a different take on the matter. Despite investments in Provident Fund, Samir thinks that the government’s move to make rates on small savings schemes market-linked is justified. He says, “This trend will continue, irrespective of who comes to power. In maybe another five to 10 years, all returns will become market linked. This has to happen over time.”

Samir thinks that going forward, if interest rates come down, it will become difficult for the government to pay much above the market rate. “For instance, if the G-Secs are yielding 7.5 per cent or 7.65 per cent, it will become painful for the government if it says that it will pay 10 per cent. How will the government earn money? It cannot pay out of its pocket. If it does, then for how long can this continue?” Paying rates not linked to the market also carries the risk of pushing India into the basket of debt-laden countries such as Greece, he warns. It is important to think long term, he reckons, adding that if interest rates and inflation reduce, savers too will eventually benefit from higher real returns.

He reasons that returns could be lower but they should be regular and steady. That’s much better, he says, than the government assuring a high return but reneging on maturity. Samir underlines the need for proper checks and balances to ensure that investors get returns on their investment. Cautioning against populism, he points to UTI’s US-64 scheme which promised high returns to investors but had to be bailed out by the government.

All said, Samir is empathetic towards the typical small scheme saver. He says, “If I am in the shoes of a senior citizen, the move will hurt. But I feel that something is better than nothing.”

‘Bad in current scenario’

Abhik Mukherjee, a Senior Business Analyst at financial product company FIS Global at Pune, is against the move to make small savings rates market-linked. The 34-year-old thinks that the investor is going to lose out on the arbitrage, as in the next few years, interest rates are expected to move down. Abhik says, “If the interest rate is fixed for a year and reset annually, the investor would continue to enjoy the arbitrage for at least one year. Now, this will be lost since the rate will be reset every quarter.” Abhik, who has a considerable amount of funds invested in PPF, is unhappy because the higher frequency of the interest rate reset would mean a lesser return for him in a falling interest rate scenario.

Abhik appreciates that the new rate setting mechanism works both ways. He says, “It will be beneficial when interest rates rise again at some time in the future. In a rising rate scenario, when rate resets happen quarterly, I will get the benefit more quickly compared with the current mechanism. But at this point in time, I am unhappy because I see the rate going down in the future.”

He thinks that the move to cut rates on short-term small savings schemes to those offered by banks may result in the loss of a separate investment asset class. He says, “Since these schemes provide an arbitrage, there is a class of people who invested mostly in them. Now, these schemes are being made comparable to bank deposits. It will be duplication. So, why will an investor go to the post office when he can go to the bank?”

Abhik also thinks that in rural areas, where the penetration of banks is not high and many invest in the small savings schemes offered by the post office, investors will take a sudden hit in the short-term schemes. He also highlights another trouble spot. “It will be difficult to explain the new mechanism to common investors. Calculating the eventual corpus will also be difficult.”

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