The interest rate on one of the most popular small savings schemes--the Public Provident Fund or PPF--is cut by 10 basis points to 7.9 per cent, the lowest level since 1980.
The interest rate on other small savings schemes, namely, Kisan Vikas Patra, Senior Citizen Savings Scheme and National Savings Certificate, is also cut by 10 basis points (100 basis points is equal to one per cent). Sukanya Samriddhi Scheme, a deposit plan for the girl child, will now fetch 8.4 per cent instead of 8.5 per cent.
As a result, for the April-June quarter, you will earn lower interest on your investment in small savings schemes.
In a declining-interest-rate scenario where bank fixed deposits (FDs) are offering a return of less than seven per cent, this can be a setback for people, especially the retirees, who invest in small savings schemes, which generally offer higher interest rates than bank FDs.
Experts believe interest rates on small savings schemes, including the PPF, may register a sharper fall if the government adheres to the formula. Interest rates on small savings schemes are market linked and depend on the yield of the government securities of comparable maturities plus a mark-up. Earlier, it was revised on an annual basis, but from April 2016, it is revised quarterly.
"The cut in interest rate of small savings schemes is marginal. It doesn't reflect the formula. The mark-up, in case of the PPF, is 25 basis points. If one calculates the average yield of 10 year G-sec for December to February, it is 6.52 per cent and with a 25 basis points mark-up, ideally, the interest rate on PPF should be 6.77 per cent," says Manoj Nagpal, CEO of Outlook Asia Capital, a consulting and wealth management firm.
"There is significant scope for the government to cut interest rate on small saving schemes as both the G-sec yields as well as the interest rate on fixed deposits have fallen around 2 per cent in the past two years. But the government is clearly not decreasing the interest rate on small saving schemes as per the formula," he added.
The yield on the 10-year benchmark government securities, against which the PPF interest rates are pegged, is hovering around 6.7 per cent and are up 2.61 per cent since the beginning of the year.
The Reserve Bank of India (RBI) took everybody by surprise after it refrained from cutting the repo rate in February's monetary policy while everybody was anticipating a 25 basis cut in repo rate. The RBI also changed its stance from accommodative to neural. This led to a sharp rise in the yield of 10-year benchmark GOI paper to around 6.9 per cent in February end.
But more recently, the yields have started softening again due to easy liquidity, fairly benign inflation outlook and the strengthening rupee.
This may lead to further reduction in interest rates on small savings schemes.
What should you do?
In a falling-interest-rate scenario when FDs are offering an interest rate of around 6.9 per cent and interest is fully taxable, there is a dearth of option for investors who want guaranteed return from a debt instrument.
Even after rate cut, the PPF is the best option as it not only provides tax-free return, deduction on investments (up to Rs 1.5 lakh), the entire proceeds on maturity are tax free. Also, PPF is even more secure and guaranteed than a fixed deposit. In case of banks deposits, you will get only up to Rs 1 lakh per account per bank in case a bank fails while in case of PPF, you get government guarantee.
Therefore, PPF will continue to remain an attractive choice, given the tax benefits and the guaranteed return.