Reduced, unreduced interest rates: should you invest in small savings?


Within 24 hours of announcing a sharp drop of 40-110 basis points interest rates on various small savings plans, the government withdrew his order Thursday. Many believe the pullback may be temporary, however, and the rates announced on Wednesday are an indication of their direction. Investors should take note of the direction in which interest rates on small savings plans and bank deposits have moved and, therefore, take a long-term call.

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What has the government announced and what has changed?

In Wednesday’s announcement, interest rates were lowered from 7.1% to 6.4% on the public provident fund (PPF), from 6.8% to 5.9% on the national certificate d savings (NSC), from 7.6% to 6.9% on the savings plan for girls Sukanya Samriddhi Yojana, and from 4% to 3.5% on small savings, for the first quarter of 2021-2022 .

The low savings rates are linked to benchmark government bond yields, which have fallen over the past year as the Reserve Bank of India cut rates to support the economy.

The restoration took place within 24 hours. Finance Minister Sitharaman tweeted: “The interest rates on the GoI (Government of India) small savings plans will continue to be at the rates that existed in the last quarter of 2020-2021, i.e. rates prevailing in March 2021. Orders issued by the supervisory are lifted.

How should we read this?

Bankers say that while the government may have postponed the rate cut for now, the writing is on the wall. “At a time when mortgage rates are below 7%, we cannot expect fixed interest rates around 7 to 8% on small savings instruments,” said a banker who did not wish to be named.

Many believe the government could announce the reduced rates again, either in the next two months retroactive to April 1, 2021, or in the next quarter starting July 1.

Economists also say that since the central government uses the small savings fund to finance its deficit and seeks to reduce the cost of deficit financing, it will opt for a reduction in savings rates small, and this could happen over the course of of the next quarter.

While a rate cut would mean the government wants people to spend and give the economy a boost, it would lead to further rationalization of fixed deposit rates by banks in the future and lower yields further. A lower rate would mean a negative real rate of return on most debt instruments, as inflation hovers around 5%.

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Should we invest in small savings instruments when the rates are higher?

Financial advisers say there is not much to do as the government is expected to announce the cuts in the coming months. “The best an investor can do is invest in a small, high yield savings instrument that has quarterly compounding frequency, because in this case he / she will earn a higher rate for at least that quarter,” provided the government does not. announce the revised rates in May with retroactive effect to April 1, ”said Surya Bhatia, founder of Asset Managers.

For instruments for which the interest rate is compounded annually, there is little that investors can do right now. Even if the government announces a rate revision after one quarter, the rates on these instruments will most likely be in effect from April 1, 2021.

What should your debt investment strategy be at the moment?

With interest rates likely to stay low for some time, there is a feeling that one should not invest in long term borrowing programs. “One should not invest in long-term programs and should invest for 2-3 years. Once the returns go up, you can go for longer-lasting funds or programs, ”Bhatia said.

Fund managers say debt investors can opt for short term funds and actively managed term funds. A fund manager who declined to be appointed said reverse repo rates had fallen from 5.15% to 4% since Dec.31, 2019, with the yield on AAA-rated corporate bonds (CBs) to 3 years fell from 6.8% to around 5.2%, which means that there has been significant transmission in high quality papers. However, during the same period, while the yield of 3-year AA rated CBs fell from 7.85% to 7.96%, the yield of 3-year A-rated CBs fell from 9.47% to 9.21%.

“Investors can opt for an active duration management strategy and look to short and medium duration funds and dynamic duration bond funds for a better return on the debt portfolio,” said one fund manager.

However, as debt investments have become unattractive due to the low interest rates on term deposits and other instruments as well, experts say stocks look even more attractive because the long-term compound benefit does not. will only increase the gap.

If you invest in a stock program for the next five years and it generates even a modest premium over a debt investment, it will generate a significantly higher return due to the composition and tax efficiency.

How are the rates determined and how does lowering them help the government?

Interest rates on small savings plans are reset on a quarterly basis, in line with changes in benchmark government bonds of similar maturity.

The yield on a 10-year government bond, for example, has fallen from around 6.8% in April 2020 to around 6.1% today. Over the past year, benchmark government bond yields have fluctuated between 5.7% and 6.2%. This gives the government leeway to reduce the rates on small savings plans in the future. While lowering interest rates will help the government reduce interest charges, it would hurt investors, especially the elderly and the middle class. Small economies have become a key source of government deficit financing, especially after the pandemic led to an increase in the government deficit, requiring more borrowing. In the revised 2020-2021 estimates, the government estimated it would increase Rs 4.8 lakh crore through small savings, compared to budget estimates of Rs 2.4 lakh crore. In 2021-2022, borrowing through small savings has been set at Rs 3.91 lakh crore. Lower rates on a higher base of central government debt help control borrowing costs.

How has inflation evolved and are banks lowering lending rates along with decreases in deposits?

The latest retail sales inflation data showed the headline figure hit a three-month high 5.03% in February, down from a 16-month low of 4.06% in January. In light of this, some of the smaller savings products may not earn much in terms of real interest rates. Wednesday’s announcement came against the backdrop of a similar cut in overall deposit rates by commercial banks.

From March 2020 to February 2021, medium-term deposit rates fell 144 basis points, according to the latest data from the RBI. The weighted average lending rate on new rupee loans sanctioned by scheduled commercial banks has fallen by 112 basis points since March 2020. The drop in deposit rates has, however, been faster relative to lending rates. The RBI noted that the adjustment in deposit rates accelerated as a result of Covid-19 due to persistent excess liquidity in a context of weak credit demand.

Over the same period, the one-year median marginal cost of the fund-based lending rate (MCLR) cumulatively decreased by 94 basis points, indicating a reduction in the overall cost of funds.


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