If the government reduces interest rate on PPF and other postal savings, do you think income funds will be affected?
Anthony D'Souza, via email
There is no direct correlation between the returns of income funds and administered products such as PPF and postal-saving schemes. The returns of income funds are market-determined, while those of PPF and postal-saving schemes are determined by the government.
However, what has happened in the past is that a reduction in small-savings rates has had a positive impact on bond markets. Market participants view the reduction in rates as a signal from the government that it is committed to a lower interest rate regime. At the same time, it also shows that the government is determined to move towards a market-determined system of interest rates. From the macroeconomic viewpoint, a reduction in the small-savings rate reduces the interest burden on the government. A lower fiscal deficit is viewed as a positive, which can help in keeping interest rates low.
In the past, when the rate of small-savings was reduced, income funds witnessed a partial spurt in returns. A 1 per cent reduction in the PPF rate in January 2000 led to a bond market rally. The average debt fund gained 1.58 per cent. In comparison to this, in the previous month (December 1999) the average gain was 1.19 per cent. At other times such as in February 2001 and February 2002, the reduction in these administered rates were followed by other developments such as the reduction in the bank rate. These 'other' events have had a more direct bearing on debt markets.
So to summarise, a change in the interest rate on provident funds and other small-savings instruments has no bearing on the returns of income funds and other mutual funds. To the extent that changes in these rates affect debt markets, they affect these funds. And that's to a very small extent.