It's time to link small savings and PF returns to market rates

Recent moves by the government to try and rationalise the multitude of savings rates in the country — many of which are still administratively set — are welcome and praiseworthy. The interest rate on seven of the eight “small savings schemes” such as the Public Provident Fund (PPF) and the Kisan Vikas Patra was cut by 0.1 percentage points. It has also been reported that the finance ministry has written to the Union labour ministry recommending that the return on the Employees’ Provident Fund (EPF) be reduced by as much as 0.5 percentage points — from 8.65 per cent per annum to 8.15 per cent. This will bring the EPF returns more closely into line with those of the other small savings schemes. The PPF, for example, now brings in 7.9 per cent per annum. As such, this is overdue. 

Banks have long argued that the prevalence of such schemes, with real returns well above bank deposits, has served to reduce the flows into bank deposits. This has also harmed the transmission into the wider economy of monetary policy decisions taken by the Reserve Bank of India. It is important that, while market rates are relatively low, these other rates are rationalised swiftly. It is far from certain what the future path of market rates might be, given that inflation might be returning to the economy. So, this might be the last window of opportunity for some time to conduct this much-needed reform to the administered interest rates mechanism. 

The EPF needs particularly close attention. It is far from clear where the EPF Organisation can invest its funds to pay for an 8.65 per cent return to its depositors. It is true that it has recently decided to up the proportion of its corpus that it invests in equity — in particular, in index funds — from five to 15 per cent. But even so, getting a return so far above eight per cent is difficult to manage, given that the EPFO, besides this small equity component, is supposed to invest mainly in government bonds and in blue-chip corporate debt. The EPFO cannot be incentivised to behave like a chit fund, dipping into old or lapsed accounts to pay out interest.

Thus, there is little reason to not directly link the various schemes, including the EPF, to the interest rates offered on the instruments that provide the bulk of their revenue. This has been spelt out in detail by the report of the Shyamala Gopinath Committee in 2011. Small savings schemes have returns set quarterly now, which is another Gopinath Committee recommendation. But the government, by retaining discretion, has allowed them again to diverge from the various benchmark bond yields. Yields fell sharply towards the end of the calendar year 2016, but the rates on the schemes were not cut equivalently in those quarters. Overall, over the past year, government security yields have lost about 0.5 percentage points, but small savings rates have come down by only 0.2 percentage points. This is a reminder that the various schemes need to be linked more firmly and transparently to the market rates so that the system works automatically and efficiently —  and there is no need or incentive for political intervention.