From UPSC perspective, the following things are important :
Prelims level : Not much
Mains level : Paper 3- Issue of linking interest rate on small saving with the G-sec yields
The article highlights the issues with linking small savings interest rates with the yield on G-sec and its resetting on a quarterly basis.
Issue of small savings interest rate
- For decades, small savings have constituted an important source of household savings, funded development programmes of state governments and offered a safe and secure source of income to senior citizens.
- Recently, a notification on reducing the interest rates on small savings schemes quickly made headlines and was rescinded after 12 hours.
- For small savers, the pandemic turned into a triple whammy: Battling job losses, higher food prices and a sharp devaluation in the value of their savings and earnings thereof.
- Interest on the Senior Citizens’ Saving Scheme was cut to 7.4 per cent, effective from April 2020, from 8.7 per cent before,
- This was done despite the Gopinath Committee had recommended the rates should never be revised more than 100 basis points in a single year.
Linking small savings rate to G-sec yields
- The suggestion to link small savings rates to G-Sec yields was first made in 2001 by Y V Reddy, then deputy governor of RBI.
- Reddy committee suggested small savings rates should be reset once a year, allowing for a spread of up to 50 basis points.
- Reddy’s recommendations were reiterated by his successor Rakesh Mohan.
- The Gopinath Committee, set up in 2009 gave its report in June 2011 and annual revisions in small savings rates linked to G-sec yields got underway effective April 2012.
- In 2016, however, the government decided to reset them on a quarterly basis.
Why link small savings rate to G-sec yields
- Such linking is premised on the argument that the money collected through these schemes is invested in central and state government securities.
- While the yield on the government securities progressively declined over time, small savings rates remained downwardly rigid.
- This resulted in an asset-liability mismatch that threatened the viability of the NSSF.
- It is also argued that people’s dependence on small savings schemes had significantly declined since formal banking had rapidly expanded.
- Moreover, for those who used small savings as safety nets there were other alternatives such as old-age pension and other similar schemes.
Issues with resetting rates on quarterly basis
- All expert committees that examined the issue had strongly argued against resetting the rates on a quarterly basis.
- The fear was it could result in unfair rewards for small savers in the event the G-sec yields remain artificially low for a certain period of time.
- It did happen in the pandemic year when small savings rates faced the steepest cut in five years.
- The changed policy on small savings is also premised on the belief that markets offer fair outcomes.
- More often than not, that is not true.
- The experience of the past year bears it out.
- While retail inflation spiked, the RBI used every trick in its bag to hold G-sec yields down.
- The government could go back to resetting the rates annually, keeping the revision under 100 basis points and allowing small savings rates a spread of at least 50 basis points, not up to 50 basis points, over and above the G-sec yields.
- Also, it may revisit the suggestion made by the Rakesh Mohan Committee to use a weighted average of G-sec yields over preceding two years — two-thirds weight for the later year, one-third for the earlier year.
Consider the question “What was the rationale for linking the interest rates on small savings to yield on G-sec? What are the issues with it?
Adopting the changes suggested here may require setting aside a few thousand crores to fill the resultant gap in the NSSF. But it is worth doing.