SMALL SAVINGS COULD BE THE ONLY PRODUCT WHERE THE SOVEREIGN OFFERS A GUARANTEE & A COMPETITIVE INTEREST RATE

A RECENT REPORT BY A WORKING group on the next phase of state Fiscal Responsibility Legislation has flagged off again the issue of restructuring small savings, addressed by two earlier committees: one headed by former RBI governor Y V Reddy and another by former RBI deputy governor Rakesh Mohan. The working group's recommendation is, at best, incremental. What it says is that in line with the policy prescriptions of these committees, the administered rate of interest on small savings should be linked to the secondary market yield of dated securities. Further, it says that the high onlending charge of 9.5% levied by the central government should be reduced. On an average, the borrowing cost of states has been far lower.

The working group stops far short of recommending a major restructuring of small savings. Decades ago, when these products were designed to encourage savings and to ensure flow of funds to finance development spending, the sovereign had few avenues for raising resources. For years, collections from small savings were a major source of borrowing for the government. But with the relative improvement in the balance-sheets of some states and with more productive investment channels opening up, including the equity markets, it is perhaps an opportune time to review the entire structure. And that too from the prism of allocative efficiency of capital.

The money raised through small savings products such as national savings certificates, post office deposits and the public provident fund is passed on to states, and their spending is generally not targeted at capital expenditure, nor is it efficient. One way out could be to divert a large part of small savings solely to funding infrastructure projects in states based on the mobilisations from each state. Given the priority for infrastructure - both social and physical - small savings could be the only product where the sovereign still offers a guarantee and a competitive rate of return. But what the government could do is to task the National Small Savings Fund (NSSF) that manages the small savings corpus to pass on the collections, at least a good portion of them, to Indian lenders who finance infrastructure projects, at a reasonable spread and on repayment terms similar to those on funds on-lent by the central government to states from small savings collections: staggered over 20 years with a grace period of five years.

To enthuse states, the allocation of money for infrastructure funding could be based on collections from each state. What is also crucial is the cost of these borrowings. After 2005, the government has not bothered to revise the rates on small savings although it had committed earlier to link them to the average secondary market yields on similar maturity government securities. Since then, thanks to more flexibility, state governments have managed to borrow from the market at rates way below the rates which the Centre charges for central plan loans. That small savings are no longer a big draw for states is reflected in the fact that a few states had made out a case to the finance ministry not to pass on such funds. By linking pricing to the market and then on-lending for infrastructure projects may not face much political resistance as long as savers are assured of preferential tax treatment and borrowers of competitive pricing.

As the Indian financial markets deepen and once banks and other financial providers reach out to a larger segment of the population, the choices available in terms of investment could signal a shift in savings. This would also result in better allocative efficiency of capital, and put an end to the disparity in the term interest rate structure in the country marked by banks having to benchmark their rates to those offered by the sovereign.

Source: The Economic Times