Why PPF interest rate could fall to a level unseen since 1980
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Why PPF interest rate could fall to a level unseen since 1980

Post demonetisation, flush with liquidity, banks have slashed their deposit rates. This is bad news for investors especially retirees who rely on interest on bank fixed deposits for regular income.

  • March 31, 2017  
  • |  
  • UPDATED   12:32 IST
Why PPF interest rate could fall to a level unseen since 1980

Post demonetisation, flush with liquidity, banks have slashed their deposit rates. This is bad news for investors especially retirees who rely on interest on bank fixed deposits for regular income.

Apart from this, what could be a big setback to the common man is that the interest rates on popular smalls savings schemes - public provident fund (PPF)- could go down to below 8 per cent- a level  unseen since 1980.

The interest rate of PPF is now market determined unlike earlier when it was determined by the government once a year.

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The new rule came into effect on April 1, this year. As per the new formula, interest rate on small savings schemes is market-determined based on the previous three-month yields of the government securities of corresponding maturities with a small mark-up. In case of PPF, the mark up is 0.25 per cent. Now, the interest rate on small savings schemes is reviewed every quarter.

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The yield of 10 year benchmark paper has slipped sharply to a multi-year low of 6.2 per cent post demonetisation from 6.8 per cent at the time of the announcement of ban on high value notes on November 8. Banks received around Rs 5 lakh crore in cash in the first few days after the government banned the use of Rs 100 and Rs 500 notes.

With poor demand for credit, banks had to deploy the excess cash in government securities which led to a surge in demand for such papers. This brought down the yield  (coupon rate divided by price) of the government securities to a multi year low, (it's inversely related to price).

It is expected that the yields may not see a sharp revision upwards in near term and may continue to remain low as there may be higher than expected rate cut by the Reserve Bank of India (RBI).

It is widely anticipated that the RBI may cut the repo rate by up to 50-75 basis points (100 basis points is equal to one per cent) in the next six months as consumer inflation one of the big factors considered by RBI while deciding rates is expected to remain subdued.

After demonetisation, as RBI has put withdrawal limits, the demand for goods and services will remain poor at least till the time things normalise and will put downward pressure on inflation. In line with the fall in bond yields, the government may consider lowering the small saving rates further.

What should investors do?
Apart from the fixed-guaranteed return, PPF also enjoys the exempt-exempt-exempt tax status. It means the contributions, interest incomes as well as withdrawals are exempt from tax. So, the experts' take is that given the tax status, PPF will continue to remain an attractive choice for investors