Small savings schemes offered by the post office have always found favour with savers, as they offer notably higher rates than bank deposits. While this anomaly was intended to be set right by aligning rates on small savings to market rates from April 2016, latest data suggests that the wide disparity still persists.

According to the RBI’s monetary policy report, the existing rates (for the October-December quarter) offered by various small savings schemes are higher by 83-203 bps than the rates based on the ‘committed formula’. For instance, while the formula-based rate for the popular public provident fund (PPF) is 6.27 per cent (based on corresponding G-Sec yield and spread), the scheme currently offers 7.1 per cent. Similarly, the five-year NSC offers 6.8 per cent currently, as against the formula-based rate of 5.65 per cent. The senior citizen savings scheme (SCSS) offers 7.4 per cent, 111 bps higher than what it should be according to the formula.

Rates across popular schemes such as PPF, SCSS and NCS were reduced by a mere 10 bps in 2019, despite 100-basis point reduction in 10-year G-Sec yield. While small savings rates were slashed by 80-140 bps in the April-June quarter this year, they were left unchanged for the July-September and October-December quarters. With G-Sec yields moving lower by another 50 bps since April, the gap between existing rates and the intended rates according to the ‘committed formula’ remains wide.

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Ad-hoc tweaking

Interest rates on small savings schemes have always been kept attractive to ensure steady flow into these schemes. For instance, from April 2012 until March 2016, rates on these schemes were hardly tweaked, despite two rate-easing cycles. To align the rates on small savings schemes with market rates, effective April 2016, the government had decided to revise them every quarter based on the prevailing rates on G-Secs.

Rates on small savings are to be fixed at a spread of 0-100 bps over G-sec yields of comparable maturities. For instance, while a spread of 25 bps over average G-Sec yield (of corresponding maturity) is applicable for PPF, NSC and five-year post office term deposits, 100 bps is applicable for SCSS, to cushion the blow for senior savers. But, interest rates on small savings schemes have not moved in sync with the movement in G-Sec yields over the past few years leading to wide divergence between formula-based rates and the actual rates.

The gap is widest in the one-two post office term deposits, with their existing rates 158-203 bps higher than the formula-based rates.

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Transmission issue

The RBI has time and again stressed on the need to bring rates on small savings in sync with market rates. Only if interest rates across different segments are aligned to market-determined rates, can transmission happen seamlessly.

Post office schemes, offering much better post-tax returns, have always enjoyed a competitive edge over bank deposits, leaving little headroom for banks to tinker with their deposit rates beyond a point.

While most banks currently offer 5-5.5 per cent rate on three-five year term deposits (few offering over 6.5-7 per cent), post office five-year term deposits offer a tidy 6.7 per cent, with SCSS enjoying 7.4 per cent rate.

Importantly, post office schemes score higher on the post-tax return basis, given the tax breaks that most of them enjoy. For instance, investment in PPF, NSC and SCSS are eligible for deduction under Section 80C up to a total of ₹1.5 lakh (under the older tax regime). Interest earned and maturity proceeds are exempt from tax in the case of PPF; in the case of NSC, interest for the first four years (reinvested) is also exempt under Section 80C.

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