Government Brings Down Administered Interest Rates Despite Turning Rate Cycle

Government bond yields are on the rise; banks have started to hike deposit rates; and a pick-up in inflation is likely to keep the Reserve Bank of India on hold. Despite all signals pointing to a bottoming out of the rate cycle, the government has brought down administered interest rates suggesting that these rates are still not as closely linked to market conditions as they ought to be.

On Tuesday, the government announced a 20 basis points cut in the General Provident Fund rate to 7.6 percent. This followed a similar cut of 20 basis points on most small savings scheme, announced last week. On Monday, the government said it would stop accepting collections for the 8 percent Savings Bond scheme. It later clarified that this would be replaced by a 7.75 percent Savings Bond.

The cuts come at a time when interest rates in the bond markets have been on the rise. The 10-year benchmark yield, to which rates on small savings instruments are linked, have risen by 67 basis points in the October- December quarter.

Calling this a delayed response on the part of the government, Harsh Roongta, an investment advisor told BloombergQuint that when interest rates were low, the government was unable to lower rates on small savings scheme in one shot due to political compulsions.

To be sure, the government has been reducing some of the administered rates slowly. The General Provident Fund rate has moved from 8 percent in January 2017 to 7.6 percent now. The rate on the 1-year time deposit has been brought down to 7 percent at the start of 2017 to 6.6 percent now.

The quarterly reset in rates, however, has not mirrored the movement of market rates. As a result, administered rates are moving lower at a time when most market driven interest rates are on the rise.

Starting April 1, 2016, the government has said that interest rates on small savings would be linked to market rates such as the benchmark bond yields. It had also said that rates would be reset quarterly.

“It was proposed that small savings schemes' interest rates will move in relation to government securities' yield of similar maturity. However, this is not followed on regular basis,” said Devendra Pant, chief economist at India Ratings.

Defending the cut in rates on small savings scheme, NR Bhanumurthy, a professor at National Institute of Public Finance and Policy, said that the government is trying to bring interest rates on small savings schemes at par with market-linked rates. He pointed out that the interest rates on government administered schemes continue to be higher than market-determined rates.

The delay in bringing administered rates down in line with market rates also means that funds continue to flow towards government schemes. This, in turn, puts banks at a disadvantage but also keeps the government's interest burden high.

According to the budget document, the receipts in small savings schemes have been estimated at Rs 1.08 lakh crore in 2017-18, while the revised estimate of collections for the previous financial year stood at Rs 95,380 crore.

Bhanumurthy of NIPFP said that lowering of rates should bring down interest payout of the central government and reduce borrowing costs for state governments, who borrow from small savings deposits when they run a deficit.