The government said on Tuesday domestic interest rates must match falling global rates, but assured the aged that it would protect their income by offering them higher-than-market rates.
The comments by Finance Minister Jaswant Singh addressed concern in the ruling coalition that falling rates are alienating middle-class voters, and persuaded analysts that the government had found a way to remove a roadblock to lower rates.
"We have to continuously match the international decline in interest rates so as to make our trade, industry and commerce competitive," Singh told the Rajya Sabha.
"But at the same time, we have to take care of the interest of those invested at a higher rate and (those who) could suffer if the interest continued to decline."
Singh said his ministry was therefore considering offering senior citizens interest rates that were higher than market rates.
"I hope...to correct it very soon...with a differential interest rate for both pensioners and senior citizens and widowers so that this kind of decline in interest rate does not affect them," he said, but did not provide details.
Indian interest rates have gradually fallen over the past few years, with the key bank rate now at a 29-year low of 6.25 per cent after the Reserve Bank of India cut it by a quarter percentage point in October.
Some members of Singh's Bharatiya Janata Party, which heads the federal ruling coalition, are worried that falling rates are alienating middle-class voters, the party's main support base.
Financial markets cheered the finance minister's comments, boosting prices on interest-rate sensitive government bonds.
The yield on the benchmark 10-year bond, which moves inversely to its price, fell to just below 6.40 per cent from a morning peak of almost 6.41 per cent.
Analysts said offering a different interest rate just to pensioners meant that the remaining rates could be market-driven and on a downward path.
"A major structural hurdle for lower interest rates has been removed," said Jayesh Mehta, head of debt capital markets at DSP Merrill Lynch. "The move to give pensioners higher rates is a good move as it will now be easier to offer market-related returns on state-run savings instruments."
A reduction in the returns on small-savings schemes could lead to a drop in banks' deposit rates, and a possible fall in lending rates, analysts said.
Banks compete directly with government schemes for savings.