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Interest Rates on Small Savings and PF Schemes
The arguments for linking interest rates on small saving (SS) schemes to market rates and rationalising the tax benefits available to them rest on removing the government's arbitrary powers in a liberalised interest rate environment. If as a result of the suggested measures SS schemes become relatively unattractive, the government would need to borrow more from alternative sources. If total government borrowing is not kept in check, yields on government securities would go up and with it the interest rates on SS schemes would also warrant upward revision.
Moorthy (2001) takes a critical look at the terms of reference of the Expert Committee to review the system of administered interest rates and other related issues (YV Reddy committee) which has since submitted its report [Ministry of Finance 2001]. Besides the two most important issues, viz, interest rates and tax concessions on small saving and provident fund schemes, the Reddy committee has also considered the institutional aspects of mobilisation and distribution of funds between central and state governments through small saving (SS) schemes. It is, however, quite understandable that popular interest would be focused on interest rates and tax concessions as these aspects are crucial from savers’ perspective. This potential wider popular interest makes the question of interest rates on SS a bit ‘political’. It also makes it necessary that the issues are widely debated. Moorthy suggests (i) 2 per cent real return on SS and PF schemes, (ii) abolition of tax rebates on SS and PF schemes, (iii) tax exemption of all interest income, and (iv) PF schemes to have fixed rates in future. This note offers comment on these issues in the light of the Reddy committee recommendations that are now available. It may be useful to make a brief mention of the relevant recommendations of the Reddy committee.
The Reddy committee has recommended linking of interest rates on different SS schemes to secondary market yields on government paper, i e, treasury bills and dated securities. It recommends that average yield on 364-day treasury bills could provide a benchmark for interest rate on one-year SS deposit. Similarly, weighted average yield on government securities for remaining maturity of five years could be benchmark for SS products having five-year maturity. As regards interest rate on PPF, the committee suggests a linkage with weighted average yield on government securities for remaining maturity of 10 years. These averages are to be computed over one year period so that short-term variations are smoothened out. It also suggests annual reset of SS rates so that changes are not too frequent. Currently PPF scheme has been operating on the principle of variable interest rate, i e, changed rate is made applicable to outstanding balances. The committee recommends continuation of the present scheme. In other schemes, i e, different certificates and other fixed maturity schemes, the changes are effective on new certificates/accounts, which also should continue. As a measure of rationlisation , the committee also recommends similar rates on products of similar maturity to reduce the ad hoc elements in interest rate fixation. It has also recommended abolition of Relief Bonds, interest on which is tax free without any limit.
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