Cut in savings rate is a sound decision

Also, govt must effect some institutional changes, such as merging PPF into NPS

On Friday, the government cut interest rates on small saving schemes, by about 0.4 per cent on five-year National Savings Certificates and 1.3 per cent on one-year time deposits. These sharp cuts may have some savers up in arms, but this was a sound decision. The government should be buying all inputs at the lowest price possible, and it is not fair to pay more to some lenders than others. The rigidity of small savings rates has also hampered the monetary policy transmission. In just over a year, the repo rate has been cut by 125 basis points, but a commensurate fall in lending rates did not come about.

On March 31, 2015, the outstanding savings and term deposits of scheduled commercial banks were Rs 80.58 lakh crore, while those in small savings instruments were Rs 9.08 lakh crore. Banks benchmark term deposit interest rates with those on small savings instruments. Till now, small savings interest rates were revised annually (while the monetary policy is reviewed bimonthly), and they were not adequately benchmarked to policy rates. In the revision that was done on March 31, 2015, the rates were left almost unchanged, even though the Reserve Bank of India (RBI) had recently cut repo rate by 0.5 percentage point. This process must become transparent, non-discretionary and market-linked. Any above-market interest paid on these instruments is a subsidy. There is an implicit subsidy on the Public Provident Fund (PPF), which is a completely tax-exempt small savings instrument. Taxation of other small savings instruments also deviates from the ideal exempt-exempt-tax or EET formulation. Funds mobilised through small savings instruments go into the National Small Savings Fund (NSSF), which is under the Public Account of India. In the Budget documents, the total increase in NSSF deposits in 2016-17 is estimated at only Rs 27,168 crore, while it increased by Rs 82,783 crore in 2015-16. Central and state governments borrow from this fund to finance their deficits. Given its investment restrictions, NSSF is a form of financial repression. One consequence of the rate cut could be that governments may need to borrow more from the market.

Two sets of institutional reforms should dovetail this move. First, it is time for the government to reconsider the need for NSSF. States are forced to borrow from it, and most of them have persistently complained about this. They would rather borrow from the market. NSSF was set up to delink small savings from Consolidated Fund of India. The Fourteenth Finance Commission found a significant mismatch between the income and expenses of the Fund. Since the Fund is essentially off-Budget, the liabilities arising from it are not accounted for in the fiscal management framework. The Fund works like an unregulated narrow bank - mobilising savings and investing them in government debt. The Fund primarily mobilises savings through the postal network. Since a postal bank is being set up, and banking access is becoming ubiquitous, the need for the Fund to help savers should be reviewed. One option could be to consider merging PPF into the National Pension System. In the long run, it is also time to start debating how government borrowing could be put on a sound platform by establishing a Public Debt Management Agency, which would handle a range of functions of debt management, and help the government ease financial repression further.