The government is considering to deregulate interest rates on small savings

The government is considering to deregulate interest rates on small savings schemes like public provident fund (PPF) and post office deposits, linking them to the prevailing interest rates in the markets.

The move will reduce returns on such schemes. At present, the interest rates on small savings schemes are fixed by the government, which are normally higher than the prevailing interest rates in the market. For example, the interest rate on PPF is 8%, which is tax-free, while that on the other similar instruments like bank deposits are lower.

The post-tax return on bank deposits is around 5.5% for those who fall in the highest tax bracket of 30%.

Towards this end, the government has set up a committee under the Reserve Bank of India deputy governor Shyamla Gopinath — to suggest the ways and means — for deregulating interest rates on small savings schemes. Small savings schemes mobilise huge amount of funds as they offer higher interest rates.

According to the Budget estimate, in 2010-11, these schemes may fetch Rs 50,300 crore, taking the total mobilisation to Rs 7,57,000 crore.

Funds mobilised under small savings schemes are disbursed to the central and state governments as debt. As the cost of the small savings funds are high, state governments pay higher interest rates (9.5%-10%) on the loans taken from these schemes compared to other sources in the market.

The 13th Finance Commission headed by former finance secretary Vijay Kelkar had suggested to bring down the interest rates on outstanding loans to 9% by the end of 2009-10.

But for this, the interest rates on small savings should also be brought down.

At the same time, according to the Fiscal Responsibility and Budget Management (FRBM) Act, states cannot borrow from open market beyond 4% of their fiscal deficits. Therefore, states are not able to benefit from prevailing lower interest rates in the market and take higher-interest loans from small savings.

The committee will also examine the new investment opportunities for the funds mobilized under small savings schemes. At present, the funds could be invested only in the central and state governments special securities. Committee will also review the administrative arrangement including the cost of operation.