| What if Small Savings Rates were Freed? |
As argued by economists the 11 per cent tax free return on Public provident fund sets a kind of bench mark for the returns on small savings which in turn leads to a higher lending rates to corporates and which in turn slows down growth and makes us uncompetitive globally. They believe that growth compulsions should actually cause a reduction in interest rates. This would help Indian industry achieve global competitiveness by reducing the cost of capital. That will happen if the RBI reduces the rate at which banks borrow from each other, reducing their cost of capital and enabling them to reduce lending rates, thus making capital cheaper for industry. And the RBI can only reduce the rate if small savings rates are down significantly. Says Dr.Surjit S Bhalla, Managing Director of Oxus Fund-: "We can't be a competitive economy if borrowing rates are more than 5-6 per cent. Blue-chip firms in the US borrow at 3.5 per cent real interest rates. In India, real interest rates are in double digits. A 1 percentage point interest rate cut can't possibly make us competitive, what we need to do is free the interest rates and let the market decide at what rate to lend and what rate to borrow."
But won’t a fall in the small savings rate hurt the interests of small savers, who form a large part of the population? No, says D.H. Pai Panandiker, noted economist and advisor to the RPG group. "It doesn't really affect a large section because PPF is used more as a tax-saving measure by the upper-middle class. PPF and other small savings instruments will still remain a very lucrative option." With the result, the interest rate cut is not likely to reduce savings in these schemes. While it doesn't hurt small savers in real terms, the freeing of rates cut helps the government by containing the fiscal deficit through savings in interest outgo plus, if the bank rate also responds likewise, then the government stands to save on the interest outgo on its borrowing programme. The economists also believe that freeing the rate will spur industrial growth. Last year the government cut the PPF rate by 1% from 12% to 11% p.a. The impact of the same has been negligible on spurring industrial growth. Says economist Surjit S. Bhalla: "We, in India, blame lack of infrastructure for everything, but infrastructure development has to happen and funds for it will only flow in when the real interest rates here are attractive. See the example of China, where the low borrowing rates have spurred infrastructure development."
The counter argument to the high interest rates is that actually the real interest rate(i.e.-the interest rate-the inflation rate) is quite low in India. With inflation at 7.8% and the PPF return at 11% , the real rate works out to 3.3%. "But this is not true Barring '98's onion-related inflation, the Wholesale Price Index has been low for the last four years.Between 1996 and 1999, the average inflation rate has been 5.3 per cent, while the average prime lending rate has stood at 13.75 per cent. That means a real prime lending rate of a whopping 8.45 per cent. Contrast these hard statistics with the 3.5 per cent figure in the US. Even in the this last year 2000-01 when due to the oil impact the inflation rose to 7.8%, the non oil inflation has lingered at 3-4%. So the real rates that the industry has had to pay have been close to 7%-8% p.a. This inhibits industrial growth.
Economists believe that further interest rate reductions can only happen if the finance ministry gives up its power of setting interest rates for small savings. "Interest rates should be determined by demand and supply. It should be the Reserve Bank of India that sets the bank rate and the ministry of finance should give up its authority of setting small savings rate." In other words, depoliticise the process of interest rate adjustment. Only then can India move towards becoming a globally competitive economy.
At a recent pre budget meet the economists felt it would not be possible to tackle the situation by effecting a direct cut in the deposit rate on small savings or provident funds.
A better way out, they argued, would be to do away with various tax incentives on small savings schemes including the National Savings Certificate. This would reduce the effective rate of return on these schemes and thereby signal lower interest rates in the rest of the economy. There were, however, some others who held a contrary view and favoured only a reduction in the deposit rates to ease the pressure on interest rates.
While the ball has been set rolling, a complete freeing of rates perhaps would be a drastic measure, however, a doing away of the tax related incentives on these schemes would definitely signal, the move in the right direction and further aligning of Indian industry and economy with the rest of the world.
Aru Srivastava
Feedback Rate this article