Spare the PF

Spare the PF

Bimal Jalan delicately punctured some illusions this week when he said lowering interest rates on small savings would have no direct impact on the bank rate. Ever since the prime minister’s economic advisory council (EAC) recommended a small savings interest rate reduction it has been assumed its advice would be followed (why publicise it otherwise?) and that such a step was essential for bringing down interest rates overall (a worthy aim). It was only a question of when an announcement would be made and by how much interest rates on provident fund and post office savings schemes would be cut. The Governor of the Reserve Bank who is a member of the EAC gave nothing away about the government’s plans but his little intervention helps restore a sense of perspective on interest rates. Jalan’s remark is a reminder that a number of factors determine the bank rate and interest rates and the small savings interest rate is probably the least significant.

A reduction in the small savings interest rate will bring down the government’s cost of borrowing but will not automatically start a virtuous circle ending with a reduced level of borrowing and downward pressure on general interest rates. It could have the opposite effect and tempt the government to borrow more. The level of government borrowing (and how the requirement is met) are important determinants of interest rates. Others are how the RBI balances the competing claims of economic growth and exchange rate stability. Having lowered the bank rate last year, for example, to stimulate growth Jalan felt compelled to follow a tight money policy later when the rupee volatility increased. Among other factors are the annual rate of inflation now eight per cent plus, demand for credit from business and industry, FDI inflows and the performance of the banking sector.

All that being so, why put the squeeze on small savings? Provident funds, still the only reliable form of savings for old age, have seen interest rates brought down by two per cent over the last three years. At 11 per cent, the rate is now about two and half per cent above the annual rate of inflation. Ceilings on the annual amount that can be invested in PF schemes keep the interest outgo in check. Overall, little justification can be seen for reducing PF interest rates or for removing tax incentives on subscriptions or taxing withdrawals. It would be imprudent and not a little unfair to mess with this core form of middle class savings.

As for post office savings, another middle class favourite, the time to think of reducing interest rates would be when bank lending rates look like softening and even then to adopt a selective approach, first targeting schemes such as National Savings Certificates and, keeping genuine small savers in mind, not cutting rates but only putting ceilings on the amount invested in monthly income or recurring deposit schemes. The government and its advisors surely understand all this. The real intention seems to be to curb state government profligacy and shift small savings into other channels. If that is so, why not say so. And there must be better ways to achieve those objectives than by clobbering small savers.