Global Outlook

The Rates for small saving schemes will now be benchmarked to those of G-secs.

Contributed by Nirmal Bang

By Nirmal Bang

As per a government directive, the returns on small saving schemes will now be market-linked.

What this means is that the rate of interest on various schemes such as public provident fund (PPF), National Savings Certificate (NSC) and post office deposits, among others, will be benchmarked to government securities or G-secs of a similar maturity with a positive mark up of around 25 basis points.

For senior citizens however, there is little more reason to cheer as the mark-up for the Senior Citizens Savings Scheme is 100 basis points. But does this necessarily mean that it is a great reason to reallocate your investments and put a larger share of it into such small savings schemes? Definitely, not.

While there is no denying that the Indian middle class has always had an affinity for small savings schemes, which are still considered safe haven  for the extremely-risk averse, there are also those who fall into the higher tax bracket and should opt for market-related instruments such as mutual fund schemes.

To better understand this government  directive, let us look at some of the popular small savings schemes.

PUBLIC PROVIDENT FUND (PPF)

This is a small savings scheme that is perhaps the most popular among a large number of Indians and a  favourite of financial planners. Till now, one could invest up to Rs.70,000 in PPF.

But now the limit has been increased to Rs.1 lakh. It is a risk-free and tax-free product and enjoys exempt-exempt -exempt (EEE) tax status. This means  that contribution, accumulation and redemption from PPF are all exempt . For eight years, now PPF has been giving a return of 8%.

Following the new announcement, the rate of interest on PPF has gone up by 60 basis points. This means that one will now get a return of around 8.6% on PPF.

Given the veritable tax advantage that this product has (not only is it tax free, one also gets an income deduction on the principal invested), it is a perfect choice for a long-term investment. If you are planning for retirement, your child’s higher education or marriage, saving through the PPF route is a smart move.

NATIONAL SAVINGS CERTIFICATE (NSC)

NSC is another favourite small savings scheme. The government has  shortened the tenure of NSC to five years from the earlier period of six years. A new NSC of a tenor of 10 years has also been introduced, which will have a positive mark-up of 50 basis points of G-secs.

For this year, a five-year NSC will reap you a return of 8.4% while a 10-year NSC will give you a return of  8.7%. And 8.7% as an isolated rate of interest may seem quite attractive to an investor.

But remember that unlike PPF, investing in NSC is a one-time  investment that you get locked into for an entire period of 10 years, where interest rates will vary each year (because it is going to be market-linked) and you can make regular investments.

Therefore, the logic of higher rate of interest does not really work in favour of NSC. Moreover, though the contribution you make to NSC  qualifies under tax exemption on maturity, the interest is taxed at one’s marginal income tax rate.

If you are in the higher tax bracket (30.9%) the effective rate of return on your NSC investment will be pretty low at about 6%.

Financial planners say that it is wiser to go in for FMPs instead of NSCs.

Though the rate of returns of an FMP cannot be disclosed by asset management companies offering them, a rough calculation suggests that an FMP offers about 9.5% rate of interest on a one-year maturity.

The tax adjusted return would thus work out to be a little over 7% which will be higher than investment through the NSC route.

POST OFFICE DEPOSITS

Post office deposits are perhaps closest to bank deposits. It has been a favourite with the risk averse as it comes with a sovereign guarantee.

Those who invest in post office deposits do so because they say that they get complete peace of mind as it is an investment product, which is completely risk free.

Financial planners, however, say that this argument does not hold ground. Bank FDs are just as safe as post office deposits.

In case of bank failure or a bank’s merger with another bank, the Deposit Insurance and Credit Guarantee Corporation offer insurance for all FDs upto Rs.1 lakh. Post office time deposits are qualified for tax exemption under section 80C of the Income-tax Act and the interest is taxable. The same holds true in case of five-year FDs.

Since the tax incentive is similar for both products, it makes sense to look at the rate of interest that is being offered. In case of post office deposits, you will get a rate of return of 8.3%.

On the other hand, investing in a bank FD will fetch you slightly higher returns - between 8.5% to 9.5%.

MONTHLY INCOME SCHEME (MIS)

Under the new regime, the Monthly Income Scheme (MIS) tenor will be five years and you will be allowed to invest Rs.4.5 lakh in a single account and up to Rs.9 lakh in a joint account.

Though it will attract a higher rate of interest at 8.2% (as compared to 8% earlier), the 5% bonus that was applicable at the time of maturity has been removed.

This really takes the edge away from the product. In the current interest rate regime, bank fixed deposits therefore make more sense. Earlier the monthly income scheme used to be considered as a favourable investment product for those who wanted to put away a fixed amount of money every month and they would count upon the maturity on bonus.

But with that being taken away, it is best to look at other comparable products before you make your investment decision.

SENIOR CITIZENS SAVINGS SCHEME (SCSS)

Designed with the best interest of senior citizens in mind, this is a product where the rate of interest has been tweaked to the highest.

SCSS which was earlier available for five years can now be extended for another three years. The new rule  suggests that the mark-up for this product will be 100 basis points. This means that if the G-Sec yield is 8%, the rate of interest on SCSS will be around 9%.

As in the case of FDs, the interest that one will receive on a SCSS will be taxable, though the contribution is exempt under 80C. Though this is an attractive option in the current interest rate regime, FDs for senior citizens is a little higher.

The other argument that works in favour of fixed deposit is that it is more liquid than SCSS. Financial planners say SCSS should be considered when the rate of interest is significantly higher than bank FDs This is not to say that these small savings schemes do not make sense in their new avatar. In the current volatile investment environment, it however makes sense to invest in those products that give you a better rate of interest.

Judge the individual merits of each of these schemes and look at your own asset allocation before you make any  investment decision. It is good to play safe, but sometimes taking a little more risk can turn out to be much more rewarding.