Here's a quick question. If you are looking at investing say Rs 100,000 for 5 to 7 years, which is the first instrument that comes to your mind?
There is a fair chance that the instrument will be one of the following:
All are savings schemes offered by the Government of India.
Then, of course, there is the very popular Monthly Income Scheme (MIS) offered by the Post Office. Here again the tenure is 6 years, and the interest rate offered is 8 per cent per annum (Sec 80 L benefits are applicable on the interest earned).
But is there a question mark over these savings schemes' sustainability?
One basic rule in finance is that the longer the tenure of the instrument, the more the uncertainty associated with it (i.e. higher the risk) and therefore higher the interest rate. Of course, another factor that would affect the rates will be the credibility of the borrower.
The listing above brings to the fore a significant distortion in the interest rate structure. Although this may not be very apparent, the graveness of the situation becomes very clear when one realises that the 10-year government paper (which is as safe as any of the instruments listed above) offers a yield of only about 5.2 per cent even as the 5 year tax free Relief Bond yields 6.5 per cent.
The chart below depicts this rather well.
| Tenure (Yrs) |
Interest Rate | |
| RBI Relief Bond - Tax Free | 5 | 6.5% |
| RBI Relief Bond - Taxable | 6 | 8.0% |
| National Savings Certificate | 6 | 8.0% |
| 10 year G-Sec | 10 | 5.5% |
| PPF | 15 | 8.0% |
| Annual Payment option |
From the chart it is apparent that there is no clear trend in interest rates across instruments (with similar credit quality) of varying maturity.
Now the question is why should the government 'borrow' via these savings schemes when it can raise money from the market at a much lower rate? It is in a way a subsidy offered by the Government of India.
The sustainability of these schemes is more in doubt today than it ever was. The reason for the same is very clear - the actual return on instruments in which these schemes invest is much lower (and falling) than what is being announced as a return.
The inherent deficit (excess of interest paid over income earned), which continues to grow, needs to be made up by the government (something like what the government had to do for the Unit Trust of India -- only that sums involved in government savings schemes are much larger).
Given the government's compulsions to clean its books of such liabilities, it is unlikely that such distortions will persist.
To put this in perspective, let's take an example.
Suppose, the government has mobilised Rs 100 in the PPF, on which it has guaranteed to pay 8 per cent p.a. compounded for 15 years. The value of this Rs 100 will grow Rs 317 approximately at maturity.
Now given that interest rates have declined significantly and the 10-year government paper is yielding only about 5.5 per cent, it is more reasonable to assume that the PPF will earn only about 7 per cent p.a. compounded. Using this return, the actual value of the assets would have grown to Rs 276 approximately.
Therefore, on maturity the government will have to make good the deficit of Rs 42. Now, that is Rs 42 of 'future' deficit for every Rs 100 invested in the PPF account today! The amount of money invested in the PPF probably exceeds Rs 500 billion (budget documents to do not provide a separate figure for the amount of money in PPF).
Do you think the government has the capacity to foot this bill? And, remember that huge deficits are simultaneously building up in other guaranteed return government schemes.
So before you decide to put all your eggs in the government's basket, think. Make sure you are well diversified in your investments.
This article forms a part of Money Simplified -- Asset Allocation for Tax Saving Instruments, a free-to-download online guide from Personalfn. To download the entire guide, click here.