Thursday, April 9, 2015

Government may link return on small savings to government bond rates

In what could be the biggest structural reform in the Indian financial sector, the Reserve Bank of India will persuade the government to link interest rates on postal and small saving deposit schemes to the market rates on government securities, addressing a longstanding complaint of banks that their hands are tied because of unfair rules.

Banks have been reluctant to lower interest rates beyond a threshold, citing administered rates on small savings as a spoilsport. Data shows that savings tend to move away from the banking system to small savings when interest rates are low. This was amply evident between 2004 and 2007 when interest rates were softening.

"There are structural constraints that we have to consider like small savings," 
RBI governor Raghuram Rajan on Tuesday told the media after the central bank's monetary policy review.

The government may try to lift this barrier for interest movement by linking the returns on small savings to the yield on government securities. "We have to make sure that small savings rates don't stand in the way of banks reducing rates. And the government has said that it would tie it to g-sec rates," Rajan said.

Following the deregulation of interest rates in 1997, administered interest rates on small savings were lowered from 2000 onwards progressively from 12% to 8% by the then NDA government which helped it lower borrowing costs in the process.

The attraction of these schemes was marginally impacted as the agency commissions through which these schemes were operated were lowered. This was a cheaper source of funds for states that were lent through the Centre at the time. But now states can raise cheaper funds on their own from the market.

Small savings corpus appears insignificant in comparison with bank deposits, but it is still perceived to be a safer avenue than bank deposits, especially in smaller cities and towns. The corpus, including liquid postal deposits and National Savings certificates among others, is about Rs 6 lakh crore. Of this, about Rs 4 lakh crore worth of postal deposits compete with Rs 86 lakh crore of bank deposits. However, direct competition is only from about 30-40% of bank deposits, which come from households and contribute to national savings.

Linking the returns on government bond yields may help government raise cheap funds, but it could impact national savings as well. RBI, in its latest financial stability report in December 2014, expressed concerns on declining savings. It said that the gross domestic savings rate declined to 30.1% in 2012-13, the lowest in the past nine years. This reduction is explained to a large extent by the fall in households' financial saving rate amid shifting preferences towards physical assets and valuables. "Revival in investment activity needs to be supported by an increase in financial savings," the report said.

Source:-The Economic Times