If anyone thought that the deregulation of interest rate on savings bank account by RBI a couple of weeks ago was a major step towards aligning interest rates to the market forces, hold on, there is more in the offing. Ministry of Finance has accepted the recommendations of a Committee headed by Mrs. Shyamala Gopinath on restructuring Small Savings Schemes, namely, PPF, NSC, and all Post Office Deposit Schemes. In a recent notification, the ministry has suggested implementation of the proposals with effect from December 1st this year.
The most important aspect is that the interest rates on these instruments (except PO Savings Bank Account, which is fixed at 4%) will now be linked to the yields on government securities of comparable maturities. The interest rates applicable to a particular year will be announced by the Government on 1st of April. In fact, the interest rates on some of these instruments were aligned to the market rate between 1999 and 2003. But since then, the rates on these instruments remained constant at 8%. This created huge inflows and outflows from these instruments depending on the market rate. For example, when the market rates were below 8%, people rushed to buy these instruments and when the market rates were above 8%, there was net outflow from these funds.
The Committee has also recommended discontinuation of Kisan Vikas Patra (KVP) and reduction in the maturity period of Monthly Income Scheme (MIS) and NSC from 6 years to 5 years. A new series of NSC with 10 years maturity will be introduced. Moreover, the accrued interest on NSC will not be eligible for tax benefits under Section 80C. As far as Public Provident Fund is concerned, the maximum contribution during a financial year has been raised from Rs.75,000 to Rs.1,00,000.
The writing on the wall is clear: Gone are the days of stable/constant interest rates!
The most important aspect is that the interest rates on these instruments (except PO Savings Bank Account, which is fixed at 4%) will now be linked to the yields on government securities of comparable maturities. The interest rates applicable to a particular year will be announced by the Government on 1st of April. In fact, the interest rates on some of these instruments were aligned to the market rate between 1999 and 2003. But since then, the rates on these instruments remained constant at 8%. This created huge inflows and outflows from these instruments depending on the market rate. For example, when the market rates were below 8%, people rushed to buy these instruments and when the market rates were above 8%, there was net outflow from these funds.
The Committee has also recommended discontinuation of Kisan Vikas Patra (KVP) and reduction in the maturity period of Monthly Income Scheme (MIS) and NSC from 6 years to 5 years. A new series of NSC with 10 years maturity will be introduced. Moreover, the accrued interest on NSC will not be eligible for tax benefits under Section 80C. As far as Public Provident Fund is concerned, the maximum contribution during a financial year has been raised from Rs.75,000 to Rs.1,00,000.
The writing on the wall is clear: Gone are the days of stable/constant interest rates!
Well said sir...My understanding is that no institution wants to ascertain the risk and give a number to it. It seems every one has lost the power to predict and passing the ball to the final element in the supply chain. Some where down the line, do you foresee a time where we refresh our saving accounts every moment/minute for dynamic balance? (similar to stock market?)
ReplyDeleteYes sir, agree with you. PPF would be attractive debt investment option considering the tax benefits and returns.
ReplyDeleteBut still some of the small savings scheme are comparatively illiquid (option is to borrow loan, does not support withdrawals). Also for salaried individuals, to take the advantage of maximum contribution limit (100,000) and tax benefits the 80C deductible contribution limit (some portion will go to EPF) may need to be increased.
Sir, Please provide your inputs on the same
Hi Murali...I feel you are stretching the logic a bit too much (at least at present)...but who knows? Some 10-15 years ago, no banker could have thought of computing interest on savings bank account on a daily basis!
ReplyDeleteHi Kishore...a lot depends on how the Direct Tax Code finally shapes up. It is proposed to increase the ceiling of 80C to Rs.3 lakhs. But the catch is not many instruments will be eligible under this section. The government is planning to (and rightly so) encourage long term investment habit. So, only few instruments like PPF, 10 year or 5 year NSC, EPF etc. would qualify for deduction. Yes, as you rightly said, the marketability is a concern.
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