Small savings schemes – Make haste to make the most

The equity market is in the doldrums due to the coronavirus impact, and corporate defaults have hurt many debt investors. For investors looking for safe debt investments, small savings schemes offered by the post office and some banks are a neat choice – with their combination of high safety and attractive rates.

Small savings schemes include Senior Citizen’s Savings Scheme (SCSS), National Savings Certificate (NSC), Kisan Vikas Patra (KVP), Sukanya Samriddhi Yojana (SSY), Public Provident Fund (PPF) and post office deposits. These schemes are as safe as they get, being guaranteed by the Centre; so, there is no worry of default. Also, the rates being offered by these schemes are quite attractive (see table).

But make haste to make the most. At the end of this month – about 13 days from now – the Centre will announce the rates applicable on small savings schemes for the April to June 2020 quarter. News reports suggest that a rate cut on these schemes is in the offing. That’s quite likely – rates have not changed for two quarters now, and a cut is overdue.

Big gap

From April 2016, interest rates on small savings schemes are being reset on 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.

But in practice, the quarterly reset mechanism is not always implemented properly, especially when G-Sec rates are on the decline. That’s because the Centre often seems reluctant to cut rates and upset investors in small savings schemes.

From about 8.2 per cent in October 2018, the 10-year G-Sec rate fell sharply to about 6.3 per cent in July 2019, rose a bit thereafter, but is now down again to about 6.3 per cent. In effect, over the past year-and-a-half, the 10-year G-Sec yield is down almost 2 percentage points.

In contrast, on most small savings schemes, the rates have hardly changed. After a steep hike of 30-40 basis points (0.3-0.4 percentage points) for the October-December 2018 quarter, the rates were cut by just 10 basis points (0.1 percentage point) during the July to September 2019 quarter reset. Then, in the next two quarters, there was no change in the rates, despite expectations of steep cuts. As a result, the rates on small savings schemes today are superior compared with many fixed income options.

For instance, the interest rate on the Senior Citizen’s Savings Scheme (SCSS) is 8.6 per cent, the Sukanya Samriddhi Yojana (SSY) gets 8.4 per cent, while the Public Provident Fund (PPF) and the National Savings Certificate (NSC) both earn 7.9 per cent. Add the tax breaks available on these products and their effective returns are much higher. In contrast, most bank fixed deposits today offer 6 – 7.5 per cent on 5-year deposits.

Cuts coming

Going by the quarterly rate reset formula, the interest rate on small savings schemes should have been cut sharply long ago. But the Centre held its hand. However, investors may not be so lucky, going forward. The Centre may wield the knife more sharply this time around. There has been a significant widening in the gap between the rates on small savings schemes and G-sec yields to which they are benchmarked. As reports indicate, the Centre will likely seek to reduce the gap this time around.

The RBI has been on a repo rate cutting spree over the past year or so to boost growth in the economy. Repo rate cuts are likely to continue given the adverse effects of Coronavirus on the economy. The RBI and the Centre want to ensure faster monetary policy transmission of low rates in the economy, and reduced rates on small savings schemes can help this cause.

Ergo: there is a high possibility that the rates on small savings schemes will be cut for the April to June 2020 quarter. So, it makes sense to lock into high rates now.

Go for fixed rate schemes

That said, invest quickly only in those schemes where it will help – that is, in fixed rate schemes where the rate at the start stays the same until maturity.

Small savings schemes can be variable rate or fixed rate products. The popular PPF and the girl-child-oriented SSY are variable rate products in which rates applicable on the investment keep changing throughout the tenure. So, new rates announced for each quarter will apply to the accumulated corpus until then. So, it will not really help to rush into investments in these schemes just to take advantage of higher rates now. The benefit of higher rates will be only until the end of this quarter, after which the new rates as per the next quarterly reset will apply on the accumulated investment.

But in fixed rate products – the NSC, SCSS, Kisan Vikas Patra (KVP), post office monthly income scheme (POMIS), and post office time and recurring deposits – the rate at the start of the investment stays until maturity. New rates announced each quarter will apply only to investments made in the quarter and will hold till their maturity. So, it makes sense to lock into higher rates now for long tenures in fixed rate category small savings schemes, especially NSC and SCSS that offer higher rates than the others.

Tax-breaks peg up returns

Besides safety and attractive rates, many of these schemes enjoy tax breaks that pegs up their effective returns sharply. For instance, in the current tax regime, the PPF, NSC, SCSS, SSY and the 5-year time deposits 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 SSY remain exempt from tax.