Interest cuts may have been withdrawn for now, but it is inevitable
Just a couple of days before the close of FY21, the government made a rather brave decision to cut small savings rates across the board. However, the decision was withdrawn with equal alacrity. But that decision may actually be inevitable.
Small savings story
On 30 March, government announced that it would effect a large scale cut in interest rates paid on small savings. These cuts ranged from 60 bps to 110 bps and marked the biggest single cut on small savings rates. Even sensitive schemes like the Senior Citizen Savings Scheme (SCSS) and Sukanya Samriddhi for the girl child saw deep rate cuts, apart from the more acceptable rate cuts in PPF and other postal deposits. But interest rate cuts were withdrawn just a day ahead of becoming effective. What explains this sharp about-turn?
Was the decision timed wrong?
Clearly, the government did not want to take such an unpopular decision in the midst of elections in West Bengal and TN and with elections coming up in UP. These states are significant contributors to small savings and hence it would be a very sensitive subject in these elections. Perhaps, the government may also have been testing waters ahead of the actual rate decision. Budget 2021 withdrew the tax benefits on CPF partially and this is just the signal that this government is willing to bite the bullet on tough issues.
A decision long overdue
While political sensitivities are a reality and the government has to contend with them, the government is right that such rates cannot be sustained. Paying over 7% on PPF, when bank FDs pay a little over 5% is not sustainable. Repo rates have fallen sharply in India since 2015 but that is hardly reflected in the small savings rates. These small savings are costing the government a bomb because it is paying much more than what it is earning and in addition also losing on tax revenues. The Budget-21 decision to restrict tax rebates on CPF is the right direction and that has to be followed up with interest cuts on small savings. After all, central borrowings did go up sharply in the last one year.
Unpopular but essential
Cut in small savings rate may reduce the yields but it is time for the cuts to be done at the earliest. At this point, the decision to cut small savings rates has a number of merits. Firstly, it substantially reduces the debt servicing burden of the government of India considering there is more than $300 billion of deposits in small savings. Secondly, it gives banks further incentive to cut rates on loans and ensure better transmission of rate cuts. Lastly, small savings with their artificially high rates and tax benefits have been distorting the debt markets for far too long. It is time for course correction. The sooner, the better!