Small savings delay interest rate reduction

MUMBAI: small savings rates are preventing rate cuts by the from being passed on to the banking system, the Economic Survey indicated, reiterating a point made by the central bank in the past. Until rates on small savings like the public provident fund (PPF) fall, term deposit rates are unlikely to decline.

Although there is a formula where small savings rates are reset by the government every quarter, the review has not been very effective. In December 2019, the RBI governor had said in the context of the transmission of monetary policy that there is also a need for greater flexibility in adjusting interest rates in small savings plans.

The survey has pointed out that while there has been a reduction in the savings deposit rate by 25 basis points (100bps = 1 percentage point) in 2019, the term deposit rate, which is plus important, has seen a decline of only 16bps from January 2019 to October 2019. “An important limiting factor seems to be the rates on small savings schemes like PPF. In 2014, the weighted average term deposit rate was the same as PPF, however, the gap between them is 115bps at Octoberend 2019,” the survey said.

Das had in his policy said the RBI has communicated its views to the government on the issue of small savings rates and the government would take a considered call in the matter.

Live plus According to the survey, RBI’s monetary easing and release of liquidity have had some impact on short term interest rates. However, this impulse is not feeding through to longer-term maturities. Since beginning of the year, yields on short term government securities (364 days T-bill) have declined much faster than that of long-term government securities (10-year G-sec).

Typically when the RBI cuts rates, yields on government bonds fall. A fall in yields hikes price of existing stock of government bonds held by banks, who make profit by selling these bonds.