In Defence Of Small Savers

Context: The recent slashing of the interest rates on small savings by the government (rescinded later) has put a light on re-examining the approach of fixing interest rates on such instruments, which contribute to the growth and offer secure income.

• At the heart is the policy decision that ties small savings rates to the G-sec yield — the rate at which the government borrows money through sovereign bonds.

Evolution of linking the Small Saving Rate to G-sec:

• The suggestion to link small savings rates to G-Sec yields was first made in 2001 by Y V Reddy, then deputy governor of RBI.
  • Should be reset once a year, allowing for a spread of up to 50 basis points.
• Reddy’s recommendations were reiterated by his successor Rakesh Mohan and later by an expert group set up in 2009 under Shyamala Gopinath to review the management of the National Small Savings Fund (NSSF).
• In February 2016, however, the Narendra Modi government decided to reset them on a quarterly basis.

Impact of Pandemic on small savers: Triple whammy, effectively reducing their earnings in real terms.

1. Job losses.
2. Higher food prices: Because average retail inflation in 2020 reached a five-year high of 6.5 %.
3. Sharp devaluation in the value of their savings and earnings: because-

• • Interest on the Senior Citizens’ Saving Scheme was cut to 7.4 from 8.7 %.
  • Rates on the Monthly Income Scheme and the National Savings Certificate were cut to 6.6 % and 6.8 %, from 7.7 % and 8 %, respectively.

Rationale behind Government decision to link small savings rates to G-sec: effectively reduce interest rates on small savings schemes.

• Markets offer fair outcomes: which will be free of extraneous influences.
• Further investments: Money collected through these schemes is invested in central and state government securities.
• To enhance the viability of small savings:  There was a time when the yield on the G-Sec progressively declined and small savings rates remained downwardly rigid (because they were not linked) — the result being an asset-liability mismatch that threatened the viability of the National Small Saving Fund (NSSF).
• Less dependence on small savings schemes: People are less dependent on them because of expansion of formal banking and available alternatives such as old-age pension and other similar schemes.

Arguments against linking small savings rates to G-sec

• Outcomes of market are not free from extraneous influences: While the retail inflation is spiked (at 6.5%), the RBI has been burdened to hold the G-Sec yield down.
  • Had it not been for the elections, the real interest earnings of small savers might have turned negative.
• Quarterly reset could result in unfair rewards for small savers: E.g. G-sec yields remained artificially low during the pandemic, which resulted in small savings rates facing the steepest cut in five years.
• Small savings play a key role in economic growth: and thus requires stability.
  • Important source of household savings.
  • Funded development programmes of state governments.
  • Offered a safe and secure source of income to senior citizens.

Way forward

• Go back to resetting the rates annually, keeping the revision under 100 basis points and allowing small savings rates a spread of at least 50 basis points, not up to 50 basis points.
• Revisit the suggestion made by the Rakesh Mohan Committee: To use a weighted average of G-sec yields over pre- ceding two years — two-thirds weight for the later year, one-third for the earlier year.
• It may require setting aside a few thousand crores to fill the resultant gap in the NSSF.