The Small Savings Schemes Conundrum

After the December monetary policy review, the focus is on small savings schemes yet again. In what has become an increasingly familiar trend, the Reserve Bank of India (RBI) faulted banks for not passing on benefits of rate cuts to consumers (read cheaper loans). On their part, banks continue to maintain that rates offered by small savings schemes are rather high. Broadly speaking, banks compete with such schemes while raising monies (fixed deposits et al); hence, the cost of borrowing become high, which in turn translates into a higher cost of lending (read expensive loans).

There seems to be consensus on the need to ‘rationalise’ small savings schemes; simply put, small savings schemes need to be made less attractive (typically a lower rate) thereby enabling banks to borrow at an inexpensive rate, and so on. But then, rationalising small savings schemes is easier said than done.

To begin with, there are political implications. Small savings schemes are perceived as (and to a degree rightly so) the layman’s investment avenues. Any attempt to make them less attractive could politically hurt the government. While on one hand, they run the risk of losing favour with citizens, on the other, it is easy to visualize the opposition hurling more ‘suit-boot’ jibes at the government :)  

Furthermore, there is some truth in the theory that small savings schemes are like the proverbial ‘silver bullet’ for a bulk of the population. The combination of low minimum investment amounts, safety (assured returns and protection thanks to a sovereign guarantee) and availability (sold through a vast network of post-offices and branches of select banks), truly make small savings schemes the layman’s investment avenue. Hence, tampering too much won't be a prudent choice. 

Clearly, authorities will have to adopt a middle-of-the-road approach. Here are some thoughts on what could be done:

To begin with, schemes that are targeted at specific investor segments such as Senior Citizens Savings Scheme and Sukanya Samriddhi Accounts will be left unchanged.

There is a school of thought which maintains that Public Provident Fund (PPF) scheme must be suitably modified. The popular scheme received a boost in 2014-15 when the maximum investment limit was increased to Rs 150,000 per annum (versus Rs 100,000 earlier). But I will be surprised if the authorities decide to tinker with PPF. Let’s not forget that retirement planning is yet to find its due acceptance in the country, and PPF features among a handful of genuine long-term investment products available to investors.         

To my mind, the Post Office Monthly Income Scheme (POMIS) and Post Office Time Deposits (POTD) will be put under the scanner. As per data from the RBI, as of Feb 2015, Rs 2,010 billion was invested in POMIS. This amounts to roughly one-third of the total corpus in all small savings schemes. Admittedly, there is a need for investment avenues that yield regular assured returns. Then again, both private and public sector banks offer products comparable to POMIS.  What sets the two apart is the rate of return; while POMIS offers 8.4% per annum, similar products from banks offer annual returns ranging from 7.25%-7.75%. It’s quite likely that the authorities will want to address the disparity.

Another aspect which is no less important pertains to the investor segment benefiting from the POMIS. It is an open secret that several affluent individuals have utilised the upper limit of Rs 900,000 available under joint POMIS accounts. Additionally, the monthly returns are invested in a Post Office Recurring Deposit account to further augment returns. Authorities will be inclined to correct this lacuna as well, thereby enhancing the prospects of POMIS being rationalised.

Then there’s POTD, the fixed deposit equivalents from small savings schemes. These deposits are offered in tenures of 1-year, 2-years, 3-years and 5-years. There’s a stark disparity between POTD rates (ranging from 8.4% per annum to 8.5% per annum) and those offered by bank fixed deposits. The popularity of POTD can be gauged by the fact that as of Feb 2015, monies parked therein (Rs 508 billion) accounted for roughly 8% of total assets held under small savings schemes.

It can be safely stated that by modifying two schemes (POMIS and POTD) which attract a bulk of monies, and leaving others unchanged, the much-desired balance can be struck.

There’s a thinking in some quarters that the way to rationalise small savings schemes is by virtually dismantling the structure, thereby ensuring that monies flow into banking channels. Such thinking is flawed to say the least. The small savings schemes framework serves an important function of offering investment options to the lay investor in the farthest corner of the country. The need of the hour is to create a level playing field between small savings schemes and bank products.

Union Budget 2009-10: More 'yeas' than 'nays'!

Stock markets have given the budget a thumbs down; on last count, the BSE Sensex had shed nearly 800 points and was southbound. Maybe it was something to do with the fiscal deficit forecast (6.8% of GDP) or possibly the markets expected far more concrete announcements in areas like disinvestment. Perhaps, the expectations of a 'big-bang' budget were too much to live up to. However, individual tax payers are likely to have a different view. In all fairness, the budget has enough to elicit a nod of approval from them.

Here are some of the major provisions:

1. Exemption limit for personal income tax hiked
Lower taxes are universally welcomed with cheers, and this move will be received equally warmly. The exemption limit for personal income tax has been hiked by Rs 10,000 i.e. from Rs 150,000 to Rs 160,000. For women tax payers, the new threshold limit is Rs 1,90,000 vis-à-vis the erstwhile limit of Rs 1,80,000. Senior citizens stand to benefit the most. With an increase of Rs 15,000, the exemption limit has risen from Rs 2,25,000 to Rs 2,40,000.

2. Surcharge on personal income tax abolished
The Finance Minister (FM) announced his intent to phase out surcharge on various direct taxes. To begin with, he has eliminated the 10% surcharge presently applicable on personal income tax. Another move that will help reduce the tax outlay, much to the delight of assessees

3. Fringe Benefit Tax abolished
This one is meant for corporates and salaried individuals. Ever since its introduction in budget 2005-06, the Fringe Benefit Tax has been the subject of much debate and discussion. Industry captains have in unison debunked the same. With the tax being abolished, the FM has acknowledged popular sentiment.

4. Section 80DD deduction limit hiked
The deduction limit for Section 80DD, which covers expenses incurred for maintenance (including medical treatment), of a dependent who is a person with severe disability has been raised from Rs 75,000 (at present) to Rs 100,000.

5. Donations to electoral trusts
The FM also has something in store for the politically inclined. He has proposed that donations to electoral trusts be eligible for a 100% deduction in the donor's computation of income. For this purpose, electoral trusts will be trusts that are set up as pass-through vehicles for routing the donations to political parties, and are approved by CBDT.

The sleeper benefit
It was widely speculated that the small savings segment would undergo a rationalisation i.e. interest rates on popular avenues like the PPF and NSC would be reduced. None of that transpired. In fact, the small savings segment has been left untouched. In other words, investors can continue to enjoy assured returns coupled with attractive interest rates and tax sops. That is a big positive. Notwithstanding the softer interest rate regime, the small savings segment continues to be a haven for risk-averse investors.

The dampener
Some might argue that not much was done for investors in the New Pension System (NPS); the FM stated that the NPS would continue to be subject to the E-E-T method of taxation. Popular opinion suggested that NPS would be brought within the gamut of Section 80C; also, speculation was rife that the annuity/maturity sum received by investors would be made tax-free. However, one must appreciate that these are early days for the NPS. Also, tax benefits spelt out for the NPS trust should be seen as indicators of the importance being accorded to the scheme. Going forward, it shouldn't be surprising, if the NPS is subject to a far more benevolent taxation method. In any case, the FM did his bit for NPS by allowing self-employed individuals to participate in the scheme and avail tax benefits thereof.

As mentioned earlier, those who expected a 'big-bang' budget are likely to be disappointed. However, while evaluating the budget, it would only be fair to take into account the challenging economic environment and circumstances that we are faced with. Given the constraints, it can be safely stated that the budget has more 'yeas' than 'nays' for individuals.

Will small savings schemes be rationalised?

Lately, several business dailies have been carrying reports suggesting that the rates offered by schemes from the small savings segment are up for review. Apparently, banks that have been nudged by the Reserve Bank of India (RBI) to cut lending rates have demanded a rationalisation in small savings schemes; the rationale being that attractive rates on the same prevent banks from lowering deposit rates. This in turn impacts their ability to reduce lending rates. A recently-appointed RBI deputy governor echoed similar views.

What are small savings schemes?
Small savings schemes are colloquially referred to as post office schemes. Broadly speaking, schemes like Public Provident Fund (PPF), National Savings Certificate (NSC), Kisan Vikas Patra (KVP), Post Office Monthly Income Scheme (POMIS) and the Senior Citizens Savings Scheme (SCSS), among others form the small savings segment. These schemes are backed by a sovereign guarantee, making them risk-free investments. Also, certain schemes offer tax benefits under Section 80C of the Income Tax Act.

The rationalisation saga
Reports of a rationalisation in the small savings segment have cropped up on several occasions over the past few years. Several panels and committees mandated by the central bank have recommended a more 'rational' structure. However, barring some cosmetic changes, the small savings segment has remained largely unchanged.

Incidentally, provisional figures (sourced from RBI's website) reveal that in 2008-09, inflows in the small savings segment grew after falling successively in the two previous financial years. It's not difficult to understand the reason for this phenomenon. The aforementioned time-frame coincided with a sharp downturn in equity markets; consequently investors smarting from heavy losses in equity and mutual fund investments chose to opt for 'safe' avenues. And investors' preference for small savings schemes in a time of adversity only bears testimony to their popularity.

Will the FM bite the bullet?
Come July 3, 2009 when the Union Budget is presented, will the FM announce a reduction in rates offered by small savings schemes? Your guess is as good as mine. However doing so would certainly qualify as a bona fide unpopular step. For instance let's consider a segment of investors like senior citizens and retirees who are largely dependent on income generated from investments. For such investors, POMIS and SCSS are 'bread and butter' investment avenues, given their need for safety of capital and assured income. Any reduction in interest rates on these avenues is unlikely to go down well with investors. Also, let's not forget that speculation is rife, that we are in store for a popular budget.

The 'middle of the road' approach
A more likely scenario seems one wherein interest rates on certain schemes will be altered, instead of 'across-the-board' changes. For instance, the PPF which runs over a 15-Yr period offers assured returns, however the interest rate (8% pa at present) is subject to change. Post Office Time Deposits (POTDs) offer an investment proposition similar to the one offered by bank fixed deposits. A reduction in interest rates on such schemes is unlikely to raise many eyebrows.

While reducing interest rates would be the direct approach to rationalisation, there are other ways as well. These would entail reducing the attractiveness of the schemes. For example, Section 80C benefits can be removed from some of the schemes. The investment tenure/lock-in can be enhanced, thereby forcing investors to stay invested for longer. Clearly, there's more than one way to rationalise the small savings segment.

What investors must do
For investors who were planning to invest in small savings schemes, now wouldn't be a bad time to get invested. This is especially true for avenues like NSC or POTDs wherein the rate of interest is locked at the time investment. This will ensure that the investments are immune to any subsequent change.

Without doubt, the small savings segment looks set to undergo an overhaul; as regards the magnitude of the same, only time will tell. However, few would dispute the role that small savings schemes can play, in terms of being the risk-free debt component in the portfolio. As always, investors would do well to judiciously select schemes that suit them the best.