In the end, the sharp cut in interest rates offered on small savings schemes announced on Wednesday turned out to be a cruel April Fool’s Day joke on small savers and senior citizens. The government had announced the reduction in interest rates on all small savings instruments, ranging from 0.4 per cent to 1.1 per cent. The cuts impacted all popular government backed savings schemes, including the Public Provident Fund (PPF) scheme, post office savings schemes, bank fixed deposits, Kisan Vikas Patras, Sukanya Samriddhi Yojana and the Senior Citizen Savings Scheme.
Within 12 hours, fears of an electoral backlash in poll-bound states forced the government to retract, with Finance Minister Nirmala Sitharaman tweeting that the rate cut order had been issued by ‘oversight’ and would be withdrawn. Quite apart from the fact that nobody bought the ‘oversight’ excuse – government decisions are simply not issued that way. Besides, West Bengal, where one phase of polling was due to take place and a state which the BJP hopes to wrest from the grasp of the Trinamool Congress, is one of the biggest contributors to the small savings kitty and has been doing so for decades.
In fact, the two biggest contributors to the various small savings schemes put together are West Bengal and Uttar Pradesh. Both are large, populous states, with high levels of poverty and lower per capita income, as well as high levels of unemployment. This also indicates why the small savings schemes, which have the dual attraction of offering slightly higher interest rates than bank fixed deposits, and also perceived as ‘government’ schemes and hence safe, are so important in such states. For the poor, for the informal sector workers, and for senior citizens and others with no fixed source of income, such savings schemes, and the interest they offer, are often a significant means of sustenance.
This is why the faux pas on the government’s part exposes a flawed approach to policymaking. After all, the lower interest rates were not some overnight decision – they have been part of a well-thought out and sustained plan to reduce the overall rates of interest across all types of instruments. The biggest beneficiary of such lowered interest rates would have been the government itself. The Centre plans to borrow over Rs 12 lakh crore from the market this year. Higher interest rates would have pushed up the cost of this borrowing substantially.
However, the flaw in a borrowing cost-oriented policy is that it ignores the flip side of the coin – savers. Already, savers who are putting their money into bank fixed deposits or even small savings schemes are, in real terms, losing money, since core inflation, at over 6 per cent, is already higher than the interest offered on deposits, that too, without counting the impact of income tax, since interest income from deposits (with some exceptions like the PPF) is taxable. However, a vast majority of Indians prefer such savings options because of the perceived safety. Nearly 85 per cent of domestic financial savings are in bank fixed deposits, small savings schemes, provident funds, pension funds and life insurance. Despite the dizzying rise of stock indices, investments in shares and mutual funds account for just over 3 per cent of savings.
A negative real return and a consequent shift into riskier stock market investments will have several negative outcomes, which may outweigh any savings to the government through lower borrowing costs. For one, this will shift savers towards physical savings, particularly gold. There are signs that this is already happening, with gold imports crossing the $10 billion mark in the month of March alone.
Such a surge exports our hard-earned foreign exchange reserves overseas, while importing gold, which is held largely in non-productive physical form like bars and jewellery. Second, the rush of savers into the stock markets – active demat accounts increased by over 10.4 million in 2020 – also increases systemic risk as too much money chases too few stocks. And, as previous global financial crises have amply demonstrated, a collapse in the stock markets could rapidly spill over into the real economy.
While lower interest paid on savings also means lower interest paid on borrowings, reducing interest rates to reduce borrowing costs alone is not enough to kickstart credit growth, and, by inference, growth. Last year, for instance, banks raised over Rs 13.5 lakh crore as deposits, but were able to lend only Rs 4.2 lakh crore, as a pandemic-hit economy struggled to revive. On the other hand, negative returns on small savings, on which the aged and the poor depend, makes a mockery of the government’s stated welfarist and pro-poor policy stance.
Since many of the small savings schemes are designed for specific social purposes – for farmers or the girl child – the impact of lower interest rates on such schemes translates into a direct impact on the vulnerable sections of the populations. Rather than looking at it from an accounting perspective, the government should view small savings schemes through the social lens.