Rate cut in PPF: Still worth your money?

The Pak Banker - - OPINION - Deepti Bhaskaran

ON 25 March, the gov­ern­ment cut in­ter­est rates on small sav­ings schemes, which in­cludes prod­ucts such as the Pub­lic Prov­i­dent Fund (PPF) and Se­nior Cit­i­zens Sav­ings Scheme (SCSS). Just as the dust was set­tling af­ter the gov­ern­ment de­cided to roll back the Bud­get pro­posal to tax Em­ploy­ees' Prov­i­dent Fund with­drawals, the cut in the in­ter­est rate of small sav­ings prod­ucts, es­pe­cially PPF, stoked an­other so­cial me­dia storm. But should this cut make you re­think your PPF in­vest­ment?

Our an­swer is a firm ' no', be­cause if you look at the re­duc­tion in the con­text of over­all fall­ing in­ter­est rate and in­fla­tion, you will re­alise that PPF con­tin­ues to be one of the best debt prod­ucts. But be­fore that, we must un­der­stand the back­ground of small sav­ings scheme. Un­til the end of 2011, small sav­ings schemes such as PPF came un­der the fixed re­turn cat­e­gory as their in­ter­est rates re­mained more or less sta­ble. So, PPF, for in­stance, gave 8% in­ter­est rate for about eight years.

But ac­cord­ing to a re­port in 2011 by Shya­mala Gopinath com­mit­tee (which was set up to re­view Na­tional Small Sav­ings Fund, or NSSF), such a fixed rate regime caused a lot of volatil­ity in col­lec­tions. When mar­ket rates de­clined, small sav­ings col­lec­tions went up as their rates re­mained un­changed. The op­po­site hap­pened when mar­ket rates went up. "This leads to a situation where when mar­ket rates are low, states are loaded with high-cost NSSF loans, and when mar­ket rates are high, NSSF loans as a source of fi­nanc­ing fixed de­posits dries up com­pletely. It is there­fore, very essen­tial to align these rates with mar­ket rates," the re­port stated.

In De­cem­ber 2011, act­ing on the rec­om­men­da­tions of the re­port, the gov­ern­ment made re­turns on small sav­ings schemes mar­ket-linked. Rates on these prod­ucts were bench­marked to gov­ern­ment se­cu­ri­ties (Gsecs) of sim­i­lar ma­tu­rity pe­ri­ods with a pos­i­tive spread of 25 ba­sis points (bps). One ba­sis point is one-hun­dredth of a per­cent­age point. For SCSS, mark-up was 100 bps, and for the re­cently launched Sukanya Sam­rid­dhi Ac­count, it was 75 bps. It was also de­cided that the gov­ern­ment would no­tify the in­ter­est rates ap­pli­ca­ble for the year on var­i­ous in­stru­ments be­fore 1 April ev­ery year.

Sub­se­quently, the gov­ern­ment felt that the pos­i­tive mark-up tilted the bal­ance of power in favour of small sav­ings schemes, which put a lot of pres­sure on banks as they were un­able to lower their in­ter­est rates. "The small sav­ings in­ter­est rates are per­ceived to limit the bank­ing sec­tor's abil­ity to lower de­posit rates in re­sponse to the mone­tary pol­icy of the Re­serve Bank of In­dia," stated a gov­ern­ment no­ti­fi­ca­tion is­sued on 16 Fe­bru­ary this year.

To bring par­ity be­tween the two, the no­ti­fi­ca­tion did two things: first, it re­moved the pos­i­tive spread of 25 bps on prod­ucts com­pet­ing di­rectly with bank de­posits. "The 25-bps spread that 1-year, 2-year and 3-year term de­posits, Kisan Vikas Pa­tra (KVP) and 5-year re­cur­ring de­posits have over com­pa­ra­ble ten­ure gov­ern­ment se­cu­ri­ties, shall stand re­moved with ef­fect from April 1, 2016 to make them closer in in­ter­est rates to the sim­i­lar in­stru­ments of the bank­ing sec­tor," it said. The spreads of PPF, SCSS, Sukanya Sam­rid­dhi Ac­count, 5-year term de­posits, monthly in­come scheme (MIS) and Na­tional Sav­ings Cer­tifi­cate (NSC) were not changed.

Se­condly, it was de­cided to cal­cu­late the in­ter­est rate on all small sav­ings schemes from the next fi­nan­cial year (FY17) on a quar­terly ba­sis to align their in­ter­est rates with the mar­ket rates of the rel­e­vant gov­ern­ment se­cu­ri­ties. The new rates for the first quar­ter of FY17 were to be no­ti­fied in March.

Given the pre­vail­ing fall­ing in­ter­est rate regime, the small sav­ings rates were re­vised down­ward (see ta­ble for new rates). If you have al­ready in­vested in a closed-end small sav­ings scheme, then the new in­ter­est rate shouldn't mat­ter as it will not im­pact your money. Closed-end schemes are those in which you make a lump sum in­vest­ment and stay in­vested for a fixed ten­ure. For in­stance, the in­ter­est rate on SCSS has changed from 9.3% to 8.6%. SCSS is a five-year prod­uct which can be ex­tended by three years. In­ter­est in­come is paid quar­terly and the prin­ci­pal is re­turned at the end of the ten­ure. If you are al­ready in­vested in SCSS, you will get 9.3% for the en­tire ten­ure. But if you plan to in­vest in the prod­uct in or af­ter April, you will get locked into 8.6%. Time de­posits, NSCs, MIS, re­cur­ring de­posit and KVP also fall un­der this cat­e­gory.

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