The Dilemma of Balancing Small Savings Rates and Fiscal Deficit Financing for the Government
Tug-of-war over Small-Scale Saving Plans
By Siddhartha Sanyal, Chief economist and head of research, Bandhan Bank
Small savings are a crucial driving force for growth and investment, mobilizing capital into India's thriving economy. Household savings, which account for approximately 18% of the GDP, comprise the lion's share of total savings. Banks deposits, making up over 40%, stand out as the leading constituent of household financial savings.
The remaining savings modes include currency, shares and debentures, small savings, life insurance, and provident and pension funds. A closer look at these alternatives reveals intriguing trends in interest rates. For instance, bank deposit rates have experienced a softening in recent months, in part due to the Reserve Bank of India's (RBI) policy repo rate reduction by 100 basis points (bps) between February and June.
On the flip side, the interest rates for EPF remained stagnant at 8.25% for 2024-25, much to the dismay of account holders. Meanwhile, small savings schemes, despite a rise in popularity, have maintained their interest rates for quite some time. With the total outstanding balance of small savings standing at a substantial `18.7 lakh crore in March 2024 and witnessed a remarkable 16% growth since March 2019, it is critical to address their interest rates.
Linking small savings interest rates to government securities yields seems prudent, but it puts the government in a delicate position. It must strike a balance between adjusting rates to reflect variations in market conditions and ensuring adequate funds for fiscal deficit financing without jeopardizing the attractiveness of these savings products.
Understanding the intricacies of the relationship between small savings, government securities, and fiscal deficit financing is essential. To clarify, let's look at these elements:
- Small Savings Schemes and G-Sec Yields: The interest rates for small savings schemes like Public Provident Fund (PPF), National Savings Certificate (NSC), Sukanya Samriddhi Yojana (SSY), and Senior Citizens Savings Scheme (SCSS) are administratively set but have a strong connection to yields on government securities (G-secs). Incorporating recommendations from expert committees, the government uses an empirical formula based on the average yield of 10-year government securities in determining small savings rates.
- Mobilizing Funds for Fiscal Deficit: The government raises funds to cover its fiscal deficit by issuing G-secs. In order to secure investors' confidence and encourage them to invest, it is imperative for the government to offer competitive yields.
- Balancing Act: The government's challenge is to adjust small savings rates in response to changes in monetary policy (e.g., RBI repo rate changes) while ensuring fiscal prudence, investor confidence, and public satisfaction.
With the decline in G-sec yields due to the RBI’s rate cut cycle, it is possible that the government might review and reduce rates on select small savings products, thereby enhancing fiscal sustainability and reducing borrowing costs for the government.
In conclusion, navigating this fine line between managing fiscal deficit financing and providing attractive interest rates on small savings schemes requires nimbleness in decision-making. By balancing monetary policy signals with fiscal prudence, the Indian government can meet its fiscal deficit financing needs effectively while maintaining investor confidence in small savings products. This delicate balancing act will not only support economic growth through accommodative monetary policy but also bolster financial security for households across India.
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Behind the Scenes:
- Interest Rate Adjustment on Small Savings: Periodic reviews of interest rates on small savings schemes are carried out by the government to ensure alignment with current economic and monetary conditions. Most small savings schemes have their interest rates linked to yields on government securities of comparable tenors.
- Mobilizing Funds for Fiscal Deficit: The government finances its fiscal deficit by issuing government securities (G-secs). Adjusting small savings interest rates to reflect changes in G-sec yields helps maintain confidence in small savings products, a significant source of household savings that end up being utilized for government borrowing.
- Balancing Act: The government must consider both economic factors, including monetary policy and fiscal prudence, as well as political considerations when determining interest rates for small savings schemes. While striking a balance between adjusting rates to meet market dynamics and maintaining fiscal sustainability is essential, ensuring public satisfaction is equally important given the popularity of these schemes among retail investors.
- The delicate balance between adjusting small savings rates and ensuring adequate funds for fiscal deficit financing is a challenge in India's economy, with small savings being a key driver for investment.
- Siddhartha Sanyal, Chief economist and head of research at Bandhan Bank, highlights the importance of household savings, which account for around 18% of India's GDP, with bank deposits being the leading component.
- The declining interest rates for bank deposits, among other savings options, are influenced by the Reserve Bank of India's (RBI) policy repo rate reduction, as seen in recent months.
- Small savings schemes, such as the Public Provident Fund (PPF), National Savings Certificate (NSC), Sukanya Samriddhi Yojana (SSY), and Senior Citizens Savings Scheme (SCSS), have a connection to government securities yields, making it prudent to adjust their interest rates accordingly.
- The government finances its fiscal deficit by issuing government securities, offering competitive yields to secure investor confidence and encourage participation.
- Navigating this balance between fiscal deficit financing and providing attractive interest rates on small savings schemes requires nimbleness in decision-making, bolstering financial security for households across India and supporting economic growth through accommodative monetary policy.
