Savings Reshuffle

Pritam P Hans        Print Edition: July 2011

Are you a risk-averse investor? Your favourite fixed-return savings instruments under the National Small Savings Scheme may soon undergo a major overhaul and interest paid on instruments such as public provident fund (PPF) and senior citizens' savings scheme will be linked to the market.

A committee formed to review the government's savings scheme under the leadership of Shyamala Gopinath, former deputy governor of the Reserve Bank of India who retired on 20 June 2011, has recommended that the interest paid on savings instruments under the scheme, except post office savings accounts, be reviewed annually and benchmarked to government securities of similar maturity periods.

To protect investors from large volatility, the rates will not be changed by more than 1 percentage point.

Rate for senior citizens' savings scheme will be 1 percentage point higher than comparable government securities. National Savings Certificates (NSCs) will give 0.5 percentage point higher than benchmark securities and other schemes, including PPF, will offer 0.25 percentage point above the benchmark.

Must read: Best savings plans for higher returns

These rates will be announced at the beginning of each fiscal based on the interest rates of government securities in the previous calendar year.

Administered Interest Rate
The proposed recommendations will make savings schemes more flexible and viable.

"The present system is anachronistic as the era of guaranteed returns is long gone for other instruments. So investors are flocking to these options and increasing the government's debt burden," says Jayant Pai, vice-president, Parag Parikh Financial Advisory Services.

"It is politically difficult to reduce administered interest rates even if it may be economically prudent to do so. This has led to an interest rate structure which is completely out of sync with the current rate regime."

Currently, instruments such as PPF and senior citizens' savings schemes are categorised as fixed-return instruments. Their interest rates, which are decided by the government, remain unchanged for years.

The other side: Banks against deregulation of savings rate

If the recommendations of the panel are implemented, you will be able to invest up to Rs 1 lakh annually in your PPF account. The provisions for premature withdrawal or taking advances against PPF deposits will also be relaxed.

"It is an important move as people were hesitant to invest into PPF due to the stringent norms for premature withdrawal," says Hiren Dhakan, associate fund manager, Bonanza Portfolio.

On the flip side, a loan against your PPF account will become costlier. The panel has recommended that the interest rate be fixed at 2 percentage points above the interest rate on PPF. At present, it is only 1 percentage point above the PPF interest rate.

Post office savings deposits will be aligned with bank savings accounts. The interest rate will be increased to 4% and calculated on daily balance once all post offices are computerised. To make the savings schemes more viable, the commission paid to agents will be reduced in a phased manner.

No commissions will be paid for PPF and senior citizens' savings scheme. For all other schemes, the commission will be reduced to 0.5%. Currently, agents are paid a commission of 0.5% for senior citizens' savings scheme deposits and 1% for PPF and other schemes.

Savings account to now give better returns

Of the two savings certificates, Kisan Vikas Patra will be discontinued in view of its misuse as bearer-like instruments. NSCs will be available in maturities of five years and 10 years. You will be entitled to tax exemption for deposits made in NSCs, but the interest income will be taxable. NSCs will not be enchased before maturity.

Even after the proposed changes, PPF will continue to be the best debt instrument for building a retirement corpus unless its tax status is changed. "PPF would now be at par with pension products offered by insurers and mutual fund houses. However, if you have a taste of equity, you can invest in a mix of equity and debt. This makes New Pension System more attractive for retirement planning," says Dhakan.

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