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.
Top Comment
Ashok
3 minutes ago
Retail inflation was 4% in January, 5% in February. All over the world, there are worrying signs that it is re-emerging as a potent, destabilising force. For years, central bankers in the West have been trying to nudge it upwards to 2%. They will soon get their wish, courtesy the huge amounts governments have been spending to help households and businesses to cope with the pandemic. 2. In India, 3.5% on savings accounts, 4 - 6% on fixed deposits, the interest subject to tax, means savers are subsidising borrowers, including large corporates. Their real rate is often negative, even as inflation is melting the principal. Especially cruel for a growing number of households in a greying society where interest income sustains the monthly budget. 3. This is the sort of predicament in which the hunt for yield starts. Depending on the status of the family, gold, real estate, chit funds - which have a special resonance in Bengal and eastern India - savings flow into largely unproductive or unsafe channels. As an arbiter, the government must do a better job of harmonising the conflicting interests of various stakeholders. Its own status as the largest borrower complicates the situation. 4. If the government is not in a position to plan for Social Security or a Universal Basic Income, the least it can do is to create a safe financial instrument, an inflation indexed fixed deposit in a nationalised bank. Given the scale and magnitude of NPAs, placing the familyâ s savings in a PSB is itself an act of patriotism.... Read More