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• Recently, a notification on reducing the interest rates on small savings schemes quickly made headlines and was rescinded after 12 hours.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.

Way forward

• 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?

Conclusion

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.

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