The >25-basis points reduction in interest rates on short-tenure small savings schemes from April 1 may have come as a huge disappointment for countless savers. For the middle class, especially for millions of retired persons, these schemes are risk-free, and provide safe parking slots for their hard-earned money. The returns these schemes offer also help them balance their budget. Read in this light, the decision to pare the interest rates on these schemes, even if only by a small measure, is bound to put the National Democratic Alliance government at the Centre in an uncomfortable position vis-à-vis a crucial component of society, the middle class, which is considered the core constituency of the Bharatiya Janata Party. The decision, however, must be viewed in the context of the big picture that is emerging on the national economy. The Reserve Bank of India cut the key policy rate by a total of 125 basis points in 2015, and it has only been partially transmitted to end-borrowers. In fact, a little less than half of this reduction had been passed on by banks to their clients. The problem, in a way, lies in the peculiar predicament the banks find themselves in. It is easy to put banks on the mat for not passing on the rate reduction to customers. Already under huge stress, they can do so only if they could correspondingly cut their deposit rates. But there is a catch here. The deposit mobilisation exercise of banks often encounters competition from these small savings schemes. By reducing the interest rates on short-term savings schemes, the government has sought to erase the ‘return advantage’ they currently enjoy over similar-tenure government securities. Indeed, it has set the stage for a uniform interest rate regime — at least from a short-term perspective — and cleared a major roadblock for banks in cutting their deposit rates, and eventually the lending rates as well. Viewed from this perspective, the move is a welcome one.
By leaving the interest rates on long-term and certain special category savings schemes unchanged, the government has sent out the message that it has in mind the larger good of society as a whole, and that it is keen to encourage people to save for the future. A distorted interest regime is the principal cause for driving the economy into a costlier zone. For individuals, no doubt, the impact of the interest rate cut on small savings schemes could be immediate and visible in terms of lower returns on their savings. However, the effect of such a cut will have a cascading effect on the entire value chain, and will inevitably bring the cost structure down for the economy. Surely, that is the right way to go. The government has indeed done well to take this less-than-popular step.
