The new financial year (2020-21) hasn’t been great with the stock markets continuing to fall. The widely popular savings schemes i.e. the small savings schemes interest rates have been cut by the Government. This includes the popular Public Provident Fund (PPF) and Kisan Vikas Patra (KVP). Why did the government cut the rates?
The reduction in small saving schemes interest rates is a part of the quarterly interest rate review that the government has been following since 2012. Until 2012, interest rates on small savings or post office schemes were set for the whole year based on yields from government securities in the previous year. Now the interest rates are based on the previous 3 months yield of Government securities and will be reset every quarter. This means that now that the rates have been reset on April 1st, the next change in interest rates will come on July 1st.
Investments already made in any of the small savings schemes before the announcement will be shielded from the interest rate cut. Only fresh investments made, starting April 1, 2020, in these avenues, would face the rate cut.
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By how much has the Small Savings Schemes interest rates cut?
Consider this: the yield on the ten-year benchmark government security has fallen from 6.79 percent in January 2020 to 6.31% now. Given this steep fall in a short time, it is no surprise that small saving schemes which are linked to government securities had to cut by the government. The rate cuts would be up to 1.4 percent for each of the investments.
For instance, the PPF which gave you 7.9 percent in the last quarter will now return only 7.1 percent for the next three months (April 1 to June 30).
The rate for KVP will be 6.9 percent, down from 7.9 percent. So, after the revision in rates, it will take 9 years to double your KVP investments (with earlier interest rates it could have doubled in 8.4 years).
Even the Senior Citizens Savings Scheme (SCSS) rates have been cut. Now investments in SCSS will earn only 7.4 percent while earlier, it was a higher at8.6 percent.
The Sukanya Samruddhi Scheme would get you 7.6 percent as against the 8.4 percent earlier while the 5-year National Savings Scheme (NSC) will earn an interest of 6. 8 percent for the next three months.
Also read: Post Office Savings Schemes: A Comprehensive Guide
Why were the interest rates reduced for Small Savings Schemes?
Even before the government cut small saving rates, the banks had already cut their deposits. After Reserve Bank of India (RBI) cut the repo rate by 75 basis pointsto 4.4 percentlast month, banks reduced their deposit rates. As you might know, deposit rates have been falling for the past year. State Bank of India (SBI)has cut deposit rates twice in March.Banks had said that the high small savings rates didn’t help with effective rate cut transmission.
The government had kept the small savings schemes interest rates untouched in the January-March quarter. However,once the RBI cut 75 bps cut of the repo rate, it acted as the trigger.So, the government had to cut small savings schemes interest rates. So, while the cuts will reduce the earnings of depositors, it will help banks cut their lending rates.
Also read: All about National Savings Certificate (NSC) withdrawal, transfer and tax benefits
Small savings schemes interest rates are still attractive
Even after the rate cut, the rates of small savings are still higher than bank deposits. Historically, bank deposits have always earned lesser than small savings schemes. While bank deposits appeared attractive in comparison to small savings schemes earlier, the difference is significant now.Let’s compare the rates.
While the interest rate for 5-year term deposits of SBI is only 5.7percent, the 5-year post office time deposit can earn you as much as 6.7percent, you are earning one percent more by investing in the post office deposit. Want to check out private sector bank deposits? A 5-year deposit with ICICI Bank will earn you just 5.6 percent while a deposit with HDFC bank will earn you just about 6.15 percent. So, small savings schemes can be seen as a far better option.
Another reason why small savingsschemes are popular is because of their tax benefits. Popular schemes such as the PPF and Sukanya Samriddhi Yojana come with added tax benefits which result in higher returns for you. You can invest up to Rs. 1.5 lakhs in a financial year in these schemes and get higher returns in the longrun.
Let’s consider PPF. Most investors consider PPF as an investment option mainly due to its Exempt ExemptExempt (EEE) tax status. EEE indicates that the interest earned on your PPF is tax-free, there is no tax on maturity and the investment you make is tax-free too. What about other small saving schemes?
Sukanya Samriddhi Yojana is attractive because of its interest rate which is one of the highest in the country for a risk-free investment or sovereignguarantee. You can open an account for your daughter who is below the age of 10 to save for her higher education or marriage. You can open a maximum of two Sukanya Samriddhi Yojana accounts with the combined investment not exceeding Rs. 1.5 lakhs per annum. Even this scheme has a EEE status.
Even the highly underrated Post Office investment option which is the Post Office Monthly Investment Scheme (MIS) will earn an interest of 6.6% for the April quarter, which is much more than what bank deposits will offer if you go for the interest payoutoption. An investor can have multiple MIS accounts under his/her name if it does not exceed Rs. 4.5 lakhs in a single account and Rs. 9 lakhs in a joint account.
The NSC has an edge over a tax-saving deposit as there is no upper limit for the investment and your NSC can be pledged to avail of a loan. The interest earned from your NSC is re-invested each year and you can get the cumulative interest which is compounded annually with the principal at maturity.
The SCSS gives quarterly interest which acts as a regular steady income for retirees.An investor can invest a maximum of Rs. 15 lakhs. You can claim tax benefits up to Rs. 1.5 lakhs under Section 80C.
Should you invest in Small Savings Schemes?
You can continue to invest in small savings schemes for your various financial goals based on your asset allocation.Since schemes such as the PFF, SCSS,and SukanyaSamriddhiYojana come under the 80C limit, you should first exhaust these investments before going for other small savings schemes. Despite the rate cuts, senior citizens should avoid investing incorporate deposits that have high default risks. Remember, all small-saving schemes come with the highest level of safety. Note that the safety is higher than even the public sector and co-operatives bank deposits. You can continue to keep PPF as a part of your retirement portfolio. However, PPF cannot be a standalone wealth creation tool for young earners. The presence of equity investments is needed to beat inflation.Having a proper asset allocation is important to enhance the returns of your portfolio in the long run.