Source says RBI asks govt to align small savings rates with market

The Reserve Bank of India has asked the finance ministry to align interest rates on small savings with market rates for improving monetary policy transmission, a government source said.

The communication from the central bank comes at a time when the interest rates on small savings schemes are on average 80-100 basis points higher than the market based formula, the source said.

The government is due to announce interest rates on small savings schemes for the Jan-Mar quarter by Dec 31.

"If the government is serious about monetary policy transmission, they need to show it by reducing administered interest rates on small savings by bringing them in line with the agreed formula," a banking industry official said.

"In recent interactions, banks have made it clear that deposit rates can't be cut primarily as it leads to money shifting to sovereign backed small savings schemes. Banks can't transmit only on lending rates, when there is a floor for deposit rates due to small savings," the official added.

As per the formula, inter rates on small savings schemes are linked to yield on government securities of similar maturities and are reset every quarter.

Though the yield on 10-year benchmark government security has fallen 78 bps so far in 2019, the government has cut interest rates on small savings schemes only by 10 bps.

Going by the agreed formula on fixing small savings schemes, the interest rate on Public Provident Fund is 86 bps higher than the market rate, while it is 81 bps higher for Kisan Vikas Patra.

The interest rate on schemes like five-year recurring deposit is actually 135 bps higher than the market rates.

Senior bank officials said small savings rates act as a floor beyond which banks cannot cut deposit rates without a diversion. This severely affects the ability to transmit RBI policy rate cuts into lending rates.

According to the monetary policy statement, though the RBI has cut the repo rate by 135 bps between February and October, the weighted average lending rate on fresh rupee loans of banks declined only by 44 bps during the period. The weighted average lending rate on outstanding rupee loans has actually increased by 2 bps during the period.

The Monetary Policy Committee resolution in December said there was a need for greater flexibility in the adjustment in interest rates on small saving schemes.

At the post-policy conference on Dec 5, Das had said that RBI has internally conveyed its views on small savings to the government.