The reversal of the interest rate cut was the right decision, but not quite enough
06-Apr-2021 •Dhirendra Kumar
On 31st March, the Ministry of Finance announced the quarterly rates for the government small-savings scheme. Just a few hours later, the rates were restored to what they were. The rates that were announced and then withdrawn were a sharp reduction on the previous rates. For example, in the Senior Citizens Savings Scheme (SCSS), the announced rate was 6.4 per cent, down from 7.5 per cent. In PPF, it was lowered from 7.1 per cent to 6.5 per cent. In terms of the income reduction, the SCSS's drop was 14.7 per cent, while for PPF it was 10 per cent.
After the rate cut was rolled back, the general assumption in the commentariat was that the rollback was due to the ongoing elections. Amongst economics and finance professionals, there was a near universal criticism of the rollback, on the grounds that market-linking of these rates and the routine resetting in line with gilt rates is the correct thing to do, regardless of how low the rates actually have to be set.
One should note - as I did - that all the people who bow before the gods of market-linking are not the kind who would have any skin in this game. No matter how far the rates are dropped, there is little likelihood of their own pockets becoming any lighter. The gods of the market are easy to worship if you don't personally have to sacrifice anything.
As I've argued earlier, we need a nuanced view of what small savings are and which one is used for what. As interest rates in the economy decline, a rate reduction for savings might make sense for schemes that are used for accumulation. However, an exception must be made for the Senior Citizens Savings Scheme. SCSS is used by a generation of savers who are long past the earning and accumulation phase of their lives. SCSS is used not for generating compounding returns and building wealth but as a source of income. The scheme has a lower age limit of 60 years and a maximum amount permissible of Rs 15 lakh. Moreover, the interest income is fully taxable.
I firmly believe that not only should the Senior Citizens scheme earn a higher interest, but it should also have a higher limit. Here's the reason: while lower inflation and interest rates and their positive impact on higher economic growth are great, they carry no benefit for retirees who are past the earning and accumulative phase of their lives. Most Indian retirees are psychologically locked into the financially destructive idea of investing only in fixed-income options. This means that lower inflation and lower interest rates bring them no benefit at all. In fact, it generally leaves them worse off because their personal inflation rates are always higher than the official ones.
The government should ensure that senior citizens who have no other source of income get a special deal in terms of the interest rates they earn. The returns that they get on their deposits should be seen not as a market-linking issue but as social expenditure, a form of direct-benefit transfers. The limit for SCSS should be raised to Rs 50 lakh and the interest rates should be delinked from automatic resetting.
It's so ironic that the cheerleaders of market-linking are a class of people who never actually depend on such deposits and the implementers are another lot whose guaranteed taxpayer-funded pensions will keep rising with inflation for their entire lives. No wonder, compassion for the plight of private senior citizens is rare.
In fact, if elections are the reason that the rate cut was cancelled, then that's a great thing. That's because elections give voice to those who will actually suffer. They bypass the class that has no skin in this game and force the political class to pay attention. That's exactly what elections are for.