Are small savings schemes still attractive after steep rate cuts?

As expected ( https://www.thehindubusinessline.com/portfolio/personal-finance/small-savings-schemes-make-haste-to-make-the-most/article31097953.ece ), interest rates on small savings schemes offered by the post office and some banks have been slashed for the April to June 2020 quarter.

It’s a very steep rate cut — ranging from 70 to 140 basis points (0.7 to 1.4 percentage points). Only the rate on post office savings account has been left unchanged at 4 per cent.

Steep cuts

The largest cut (1.4 percentage points) have been made in the 5-year recurring deposit (from 7.2 per cent to 5.8 per cent) and in the 1-, 2- and 3-year time deposits (from 6.9 per cent to 5.5 per cent). A bit surprisingly, even the Senior Citizen Savings Scheme (SCSS) has seen a massive 1.2 percentage point cut from 8.6 per cent to 7.4 per cent. Perhaps for the first time, the SCSS now earns less than the Sukanya Samriddhi Scheme (7.6 per cent) for the girl child.

The rate on the National Savings Certificate (NSC) is down 1.1 percentage points from 7.9 per cent to 6.8 per cent. The Sukanya Samriddhi Scheme (7.6 per cent) and the popular Public Provident Fund (7.1 per cent) have also seen sharp rate cuts of 0.8 percentage points. So have the 5-year post office term deposit (6.7 per cent) and the post office monthly income scheme (6.6 per cent) with cuts of 1 percentage point. The least cut (0.7 percentage points) has been seen in the Kisan Vikas Patra (6.9 per cent). Interestingly, in a reversal from the past, the KVP now earns higher returns (marginally) than the NSC.

Cuts were overdue

These rate cuts were on the cards for quite some time now. From April 2016, interest rates on small savings schemes are being reset on a quarterly basis. The idea is to align the rates on these schemes with those on government securities (G-Secs). So, as G-Sec rates move up or down, the rates on small savings schemes are also supposed to move every quarter.

Going by this quarterly rate reset formula, the interest rate on small savings schemes should have been cut sharply long ago. Over the past one-and-a-half years, the 10-year G-Sec yield is down almost 2 percentage points. In contrast, on most small savings schemes, the rates had hardly changed (just about 0.1 percentage points). The rates on small savings schemes had not changed for two quarters now, and a cut was overdue. With the RBI on a repo rate cutting spree and the Centre keen to ensure transmission of cheaper rates in the economy, the axe finally fell on small savings schemes this time round.

Still worthwhile

After these steep cuts, do small savings schemes still remain attractive for investors? Yes, some of them still make the cut. One, their high safety factor — being guaranteed by the government — is a major positive. Next, compared with most bank deposits, rates on some small savings schemes remain better despite the cut.

Most banks today offer a rate of 6-7 per cent on their term deposits, and this is taxable. Bank deposit rates are likely to go down with the recent 75 basis points repo rate cut by the RBI to combat the coronavirus impact; SBI has already cut its deposit rates and others may follow suit.

Some small savings schemes — such as PPF, Sukanya Samriddhi Scheme and SCSS — continue to offer rates over 7 per cent. Some, such as NSC, 5-year post office deposits and KVP, offer a notch or two below 7 per cent. These rates remain relatively attractive in the current scenario.

But some small savings schemes have lost sheen; for instance, the post office recurring deposit and its 1-, 2- and 3-year term deposits.

Tax breaks peg up returns

Besides safety and attractive rates, many small savings schemes enjoy tax breaks that peg up their effective returns. For instance, in the current tax regime, the PPF, NSC, SCSS, Sukanya Samriddhi Scheme and the 5-year time deposit are eligible for deduction under Section 80C up to a total of ₹1.5 lakh a year. Besides, the interest earned on the NSC, if shown as reinvested, is also covered under Section 80C, in the current tax regime. In the optional new tax regime, applicable from April 1, the Section 80C benefit is not available, but the interest earned and maturity proceeds of PPF and Sukanya Samriddhi Scheme remain exempt from tax.

The alternatives

Investors can also look at some other options besides the small savings schemes. One, the 7.75 per cent Government of India bonds, issued by the RBI, could be a good alternative, if still available. While the interest is taxable, the rate is attractive in the current scenario and the safety quotient is high. But the instrument is not being displayed on the portals of some brokerages.

Next, a handful of private banks and small finance banks offer better rates than small savings schemes; the interest is taxable. With the hike in bank deposit insurance to ₹5 lakh in the recent Budget, there is a bit more comfort on the safety aspect here. But don’t go overboard on these bank deposits; higher returns often come with higher risk.