1% drop in small savings' rate may cut income by 15%. Measures are needed to save these schemes

By Dhirendra Kumar

The interest rates on small sovereign savings products have been reduced sharply. This is a result of the sharp reduction in the repo rate that the Monetary Policy Committee decided in its meeting on 26 March. The way savings rates are determined now, this linkage is more or less automatic as the rates on such savings schemes are fixed every quarter based on yields on government bonds. The sharp reduction is a result of the RBI’s move to cut interest rates by 0.75 %, taking the repo rate to 4.4%.

So, in effect, the action taken by the RBI to provide a monetary cushion to the looming Covid recession, has caused a reduction in the interest earnings of those who have money in sovereign deposit schemes. Even though each step of this chain of causes and their effects is logical, the end result is disastrous for those who depend on these schemes for post-retirement income. The reduction in earning of such people is enormous. What looks like a 1% drop in the interest rate could actually be a 15% reduction in the income of the saver. For example, if you have a Rs 20 lakh in your Monthly Income Account, you were getting an annual interest of Rs 1.52 lakh. Now, this comes down to Rs 1.32 lakh, a reduction of 13.2%. The worst impact is on one-year term deposit, where the amount you earn has gone down by more than 20%.

Even though the monetary policy logic of lowering these rates sounds fine, some special provision is needed in the current situation for small savings schemes, especially in those for senior citizens and the girl child. These schemes have a specific social purpose and utility. The government spends a lot of money on a lot of things, many of them useless. A small extra outgo of interest on such schemes should be seen as a social expenditure rather than some great anomaly in the monetary policy being followed.

At this point of time, we are entering a period of great uncertainty. Governments— both states and Centre—will look after their own employees, with DAs and salaries getting bigger as they always do. In the private sector, many of those who are still in their working life will also cope, as the economy eventually recovers. People will earn less, face hardships but have a future to work for. None of this stands true for retirees. They are out of the economy now. An economic recovery will not mean more earnings for them. In fact, in one way or the other, it will only mean higher costs for them. On the other hand, lower interest rates will mean lower income. Except for the prosperous few who may have some inflation-linked means of earning like house rent or a pension, this is an accelerating crisis for them.

The process for handling the economic fallout has just begun. Even the inputs that will drive these measures are not in place yet so one can hardly predict what will happen. No doubt there will be many rounds of economic packages. There is no doubt that every country is looking at massively reduced tax revenues and increased government expenditure. This is uncharted territory for everyone. However, mechanically following set formulae for determining small savings interest rates should not be done. These interest payments are a key income source for a vulnerable section and the packages that are to come must keep this fact in mind.

(The writer is CEO, Value Research)