Expect more transmission in rates across the board
Thankfully, the furore over the decision to tax part of EPFO withdrawals—a misconceived move because it forced savers into low-yielding annuities—and its subsequent reversal has not dimmed the government’s reform intentions. In keeping with an earlier promise to reset interest rates on small savings every quarter instead of every year as now, interest rates on a 1-year postal deposit have been cut (reset, actually, since the spread over G-Secs remains unchanged) to 7.1% from 8.4%, those on a 5-year NSCs have been cut to 8.1% from 8.5% earlier, those on 5-year senior citizen schemes have come down to 8.6% from 9.3% earlier. Given the Rs 400,000 crore that is expected to be collected from these schemes this year, even a 100 bps savings—three-fourth of savings come from post office deposits where the cuts are the largest—means a substantial saving of Rs 4,000 crore. Depending on how much states take from the small savings pool, some part will be passed on to states—with small savings rates coming off, states will also borrow less from the market which, in turn, will also lower bond rates. And since banks will now find the competition from small savings schemes reduced, they will be more willing to lower deposit, and hence, lending rates. All told, expect a lot more transmission of rate cuts across the system, more so if RBI cuts repo rates next month.
Certainly, small savers will protest, but the government will do well to explain that the reset protects their real incomes. Based on today’s CPI inflation of 5.2%, the real income on a 1-year postal deposit is still 1.9%, a rate which savers seldom get in fixed deposits. Indeed, as long as government demand for funds remains voracious, the G-Sec rate, at 7.5% right now, will remain significantly over the CPI rate—in any case, Friday’s resets do not touch the spreads on small savings which remain at 25 bps for most schemes, 75 bps for the Sukanya Samriddhi Scheme and 100 bps for the 5-year paper for senior citizens.
Given the furore over the EPFO, finance minister Arun Jaitley would do well to start an early discussion on the tax incentives given to various savings and pensions schemes, a veritable noodle bowl today. After the proposal to tax EPFO was withdrawn, EPFO earnings are tax-free but 20% of the NPS corpus is taxed and 40% has to be mandatorily invested in annuities that, right now, give low yields; the interest rate on NSCs is taxed but that on PPF is tax-free; while you get tax breaks of up to R150,000 under Section 80C on many investments, you get another R50,000 for the NPS (Section 80CCD). There are, in addition, special tax breaks for Sukanya Samridhi, housing and education loans and even health insurance (Section 80D). Since the finance minister is trying to clean up sops on the corporate tax end, why not do the same for personal income taxes as well? A tax deduction of R150,000, for instance, means a saving of R50,000 at the top tax-bracket—add to this, the housing loans, NPS, medical insurance etc. In which case, why not just remove the exemptions and hike the basic level below which no tax is paid?