Small Savings Schemes Continue To Score Despite The Steep Rate Cut

The deep cut in small savings rates by the government wasn’t an unexpected move. After the Reserve Bank of India’s steep cut in the repo rate and cash reserve ratio, the government was expected to announce rate cuts for better transmission of interest rates. The result: Cuts of 70-140 basis points (bps) in small savings rates for the April-June quarter, on Tuesday.

Senior citizens and Public Provident Fund (PPF) investors will feel the pinch the most. Senior Citizens Savings Scheme took a 120-bps knock, from 8.6 per cent 7.4 per cent and PPF from 7.9 per cent to 7.1 per cent (80 bps). Other schemes whose rates were slashed include one-year to three-year time deposits – 140 bps (see table). Only the savings deposit rate was kept unchanged at 4 per cent a year.

Says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor:

“These rates were artificially high. The 10-year government bond yield is at 6.13 per cent currently. So, there is no way that the PPF rate could be sustained at 7.9 per cent. High small savings rates meant that banks, too, had to keep their deposit rates high. This prevented the transmission of lower interest rates through the economy. From the retail investor’s perspective, it is a loss, but it is not unfair.”

Agrees Adhil Shetty, chief executive officer, Bankbazaar:

“Despite the rate cuts, small savings schemes like the PPF, NSC, Post Office Time Deposits and others offer assured returns and capital safety. They form the foundation of our investment strategies. Considering the global situation and the looming recession, lower interest rates should not deter you from continuing your investments in these schemes to achieve your long-term financial goals.”

Even though the rate cut was largely on expected lines, this has been the deepest cut in many years.

However, many of these schemes remain attractive because of the higher rates being offered. Banks have already started slashing deposit rates. The State Bank of India cut borrowing rates by 75 bps but it also cut the deposit rate by 20-50 bps for retail customers. So, a person who puts in money for three months in SBI fixed deposit will get 5 per cent, and the bank’s one-year rate stands at 5.70 per cent. Senior citizens will get 50 bps more at 6.2 per cent.

Even debt funds have not fared too well. The category average return of ultra short-term funds has been 1.26 per cent over the past three months, and their one-year returns has been 0.53 per cent. Across all debt fund categories, the category average returns have been -1.37 per cent to 4.46 per cent over three months. For the entire year, the range is wide from -2.64 per cent to 15.68 per cent.

A significant reason why these should continue to be a part of the portfolio, especially the risk-averse, is the mayhem that is going on in the debt fund segment. With a large number of companies defaulting during the past 18 months, most debt funds have had to resort to side pocketing – the process which allows a fund house to separate bad assets from liquid assets in a portfolio as it could get impacted by the credit profile of the underlying bad instrument. Some fund houses have side pocketed securities of several companies in their different debt schemes. And that is not a good sign even for the risk-taker.

Investors should compare the post-tax return on small saving schemes with other fixed-income instruments before making a choice. And invariably, small savings schemes will do quite well. Like Raghaw says: “Returns will fall across the board – in other debt products as well. You are unlikely to find alternatives that will give you a better rate of return. A tax-free bond is giving a yield of around 5.5 per cent in the secondary market whereas you are still getting 7.1 per cent in PPF.” Products like PPF and Sukanya Samriddhi Account, which get exempt-exempt-exempt treatment, remain attractive.