Rate on small savings seen lowered in Budget

Finance Minister Yashwant Sinha is likely to bite the bullet and lower returns on government-run savings schemes in the coming Budget, traders and analysts said on Tuesday.

This, in turn, is expected to lead to a wider range of cuts in bank deposit and lending rates which could spark a pick-up in economic activity.

The decision will not be an easy one and is likely to spark fierce opposition from political parties, organised labour and the public which depend on these savings for tax breaks and assured returns. Rates on such schemes have already been cut by 250 basis points in two years.

Bankers and analysts predicted a cut of 50-100 basis points and possibly some reduction in tax benefits on the schemes to bring down high real returns.

"A savings rate cut is essential if the economy is to move to a lower rates structure," said Indranil Pan, associate vice president at Kotak Mahindra Capital Company.

"Banks compete with these schemes and this forces them to keep deposit rates high."

Popular savings schemes such as the Public Provident Fund pay a tax-free interest of 9.5 per cent which, at the highest tax rate, yields 13.7 per cent. In comparison, long-term bank deposits pay 9.5 per cent.

That high small savings rates have kept interest rates sticky at the longer end was evident in 2001 when India cut rates with its economy sluggish and inflation plumbing new depths.

While the benchmark 10-year central bond yield tumbled 300 basis points to 7.94 per cent, major banks' long-term deposit rates slid just 100-175 basis points.

DIFFICULT MOVE

Interest rates on small savings schemes are among the few still fixed by regulators in India. All bank interest rates are set by individual banks, except the rate on savings accounts, which is fixed by the central bank.

Social and political compulsions limit the move to market-determined rates on small savings schemes.

India lacks a social security system and these schemes provide a nest egg for the future. And with financial markets still evolving, other long-term options such as insurance and mutual funds do not offer safety and high returns.

Small savings, as a percentage of net household financial savings, rose to 13.8 per cent in 1998-99 (April-March), latest published data showed, from 7.9 per cent in 1996-97.

Net collections in 2001-02 are estimated at Rs 470 billion ($9.66 billion), which will take the total outstanding under such schemes to Rs 3.05 trillion. This represents a rise of 18.23 per cent on the year.

For millions of retirees and other dependents, returns from these investments are an important source of income.

"A rate cut would hit these people directly, lower their disposable income and negatively impact their consumption," said Dhananjay Sinha, analyst with J M Morgan Stanley.

"Capital formation may also be hit if investors shift to unproductive physical assets such as gold or real estate," said Cherian Verghese, head of Corporation Bank.

An expert committee suggested that in the medium term, the rates be benchmarked to an indicator such as the inflation rate or central bond yields.

For the near term, this a difficult option.

"The government does not have computerised systems by which they can track savings in remote areas which will limit the extent to which they can revise the rates," Pan said.

"A cut will trigger a downward adjustment in banks' lending and deposit rates," Verghese said. "Banks' spreads are under pressure as bond yields are much below their cost of funds."

But this alone is not enough to lower the cost of funds in India, he added.

Reuters

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