Banking : Report of the Committee on Comprehensive Review of National Small Savings Fund
Summary of Recommendations
The Central Government on 8th July, 2010 constituted an Expert Committee under the Chairpersonship of Smt. Shyamala Gopinath, Deputy Governor, Reserve Bank of India for comprehensive review of the National Small Savings Fund. The terms of reference of the Committee include review of the existing parameters for the small saving schemes in operation and recommend mechanisms to make them more flexible and market linked; review of the existing terms of the loans extended from the NSSF to the Centre and States and recommend on the changes required in the arrangement of lending the net collection of small savings to Centre and States; review of the other possible investment opportunities for the net collections from small savings and the repayment proceeds of NSSF loans extended to States and Centre; review of the administrative arrangement including the cost of operation; and review of the incentives offered on the small savings investments by the States.
The Key Principles
Number of schemes
The Committee, while conscious of the multiplicity of schemes, recognised that most of the schemes serve the thrift needs of various sections of the population, especially small savers. It has, therefore, recommended closure of only one existing scheme – the Kisan Vikas Patra (KVP) while recommending continuation of all other schemes with suitable modifications.
Benchmark of Small Savings Instruments
Taking into account the various considerations, the Committee agrees with the recommendations of the Reddy and Rakesh Mohan Committees that the secondary market yields on Central Government securities of comparable maturities should be the benchmarks for the various small savings instruments (other than savings bank deposits, which do not have a fixed maturity). The rate of interest on savings bank deposits would remain fixed at 4 per cent per annum.
The Committee recommends that the Government may adopt the formula suggested by the Reddy Committee, as it will allow a quicker pass through from the recent market rates to the administered rates. Accordingly, a one-year reference period would be adopted. As compared with the Rakesh Mohan Committee formula, however, the chosen formula is likely to increase the volatility in the administered rates. The average of the month-end secondary market yields announced by FIMMDA (which the RBI has permitted the commercial banks to use for the valuation of their Government securities portfolio) may be used for this purpose. The yields, so obtained, would be rounded off to the nearest 10 basis points. (Thus, if the rate as per the formula is 6.120 per cent, the rounded-off rate would be 6.10 per cent).
The Committee also agrees with the recommendation made by the Rakesh Mohan Committee on placing a cap of 100 basis points so that the administered rates are neither raised nor reduced by more than 100 basis points from one year to the next, even if the average benchmark interest rates rise or fall by more than 100 basis points. This would reduce the year-to-year volatility in the administered rates.
In the developed economies, the issuer appears to offset the higher transaction costs associated with retail debt instruments by offering a lower rate of interest than that in wholesale markets. Taking into account the interests of the small savers, and in view of the absence of social security among the unorganized sections of the society, as also the liquidity augmenting measures for various instruments suggested by the Committee, the Committee recommends a positive spread of 25 basis points, vis-à-vis Government securities of similar maturities with a few exceptions. Being lower than 50 basis points recommended by the earlier Committees, it would also contribute to the viability of NSSF.
On a balance of consideration, the Committee is of the view that the administered rates may be reset on an annual basis which will balance between the objectives of the need for closer alignment of administered interest rate with market rates and the reduction of its volatility arising from more frequent resetting.
Date of Notification of the Rate of Interest
The administered rates may be notified by the Government every year on April 1, effective 2012. It is considered necessary to provide for a three month lag between the last day of the reference period and the date when the revised rates would be affected. Accordingly, the reference period for averaging the small savings rate would be the calendar year (as was also recommended by the Reddy Committee). An exception may be made for 2011-12; for example. If the revised rate is announced on July 1, 2011, the reference period of April 2010-March 2011 could be taken.
TDS, CBS and KYC
The rationalisation of instruments is aimed at achieving public policy objectives of catering to the needs of financial security of small savers. The nomenclature of ‘small’ savings and the higher than market rate of interest makes it imperative to place a ceiling on investments in individual instruments so that the schemes cease to pose a fiscal burden on the Centre and the State Governments even while adequately catering to the interests of the target groups. Ceilings may also be strictly enforced, since these instruments are not subject to TDS. The Committee is not recommending any change on TDS on small savings instruments but is of the view that the issue of TDS on small savings instruments may be considered by the Government while drafting the DTC.
In the absence of the use of core banking solution (CBS) linking all post offices at present, it is possible for individuals to avoid the ceiling on various instruments by parking their savings across more than one branches. In future, since the Department of Posts is undertaking CBS in major post offices, it would be possible to enforce the ceiling for a majority of small savers.
Further, KYC may be enforced strictly to prevent money laundering/generation of black money. The computerization and the introduction of CBS among postal savings bank branches would enable monitoring of the adherence to the investment limits prescribed for various small savings instruments.
Rationalisation of Instruments
The Committee‘s recommendations on the rationalization of instruments of small savings are as under :
Savings Account Deposits
The Reddy Committee (2001) had recommended that as long as the rate of inflation is more than 3.5 per cent, the rate of interest on postal savings deposits may continue to be 3.5 per cent. Incidentally, the rate of interest on postal savings deposits had been aligned with the savings deposit rate of commercial banks since March 2003. The Reserve Bank has since increased the savings bank deposit interest rate from 3.5 per cent to 4.0 per cent, effective May 3, 2011 since the spread between the bank savings deposit and term deposit rates had widened significantly. The Committee is of the view that the postal savings deposit rate may be similarly raised by 50 bps to keep it in alignment with bank savings deposit rate. Further, the Reserve Bank has advised scheduled commercial banks to pay interest on savings bank accounts on a daily product basis with effect from April 1, 2010. The Committee is of the view that the Government may consider applying the same formula for the calculation of the interest on savings deposits of post offices once the post offices are fully computerised. On the issue of relaxation/removal of the ceiling, the Committee considered the following two options: if the ceiling has to be removed, the interest income may not be exempt from income-tax under section 10 of IT Act. Alternatively, if the income-tax exemption is to continue, the current ceiling may be retained. Taking into account the above considerations and the need for harmonisation with the DTC code removing most tax exemptions, the Committee favours the first option.
5 Year Recurring Deposit Scheme
To improve the liquidity of the scheme which is needed more by the smaller savers, the Committee is in favour of a reduction in the lock-in period of the scheme from 3 years to 1 year. The penalty on premature withdrawal could be fixed at 1% lower rate of interest than time deposits of comparable maturity. The rate of interest could be benchmarked with G-sec yields of 5 year maturity as was recommended by the Reddy Committee. The 4 per cent commission payable to agents makes it an agent driven scheme. Financial literacy programmes should promote postal savings instruments and the commission should be progressively reduced to 1 per cent over a period of up to three years (by a minimum of 100 bps each year).
Time deposits (of 1, 2, 3 and 5 year maturity)
The postal time deposits, designed to promote thrift, may not enjoy similar liquidity as bank deposits. However, the liquidity of postal time deposits could be improved keeping in view the interest of the small savers. Accordingly, if withdrawn within 6-12 months, the Committee recommends that savings bank deposit rate may be paid (as against nil at present). If deposits are withdrawn prematurely after 1 year, a 1 per cent lower rate of interest than time deposits of comparable maturity may be offered.
Monthly Income Scheme (MIS)
Keeping in view the higher interest rate (inclusive of 5% maturity bonus) on MIS vis-à-vis market rates, the Committee recommends that the bonus should be abolished and the effective rate of interest be aligned with the market rate. Further, the Committee favours retaining the present ceiling on MIS as it would adequately serve the interests of the small savers. The Committee also favours a reduction in the maturity of MIS to five years with the rate of interest benchmarked to 5 year G-secs.
Senior Citizens’ Savings Scheme (SCSS)
The Committee is of the view that SCSS is serving a useful goal as an instrument of social security. At the same time, the bank dominated intermediation of savings under SCSS appears to reflect the rural-urban distribution of the savers under this scheme. As a higher mark-up of 100 basis points over 5-year G-sec security (as against 25-50 basis points proposed for other schemes) is recommended, the Committee is currently not in favour of an upward revision in the investment ceiling, presently fixed at Rs. 15 lakh and deemed adequate, keeping in view the fiscal implications.
Public Provident Fund (PPF)
The Committee considered the suggestion of the Department of Posts and some of the State Governments of an increase in the annual investment limit on PPF to Rs. 1 lakh from the current ceiling of Rs. 70,000 to coincide with the ceiling on section 80C of the I.T. Act. The Committee noted that in the past, the investment limit on PPF used to be usually revised in tandem with that of the exemption ceiling for section 80C. In the last instance, however, notwithstanding the upward revision of section 80C from Rs. 70,000 to Rs. 1 lakh, the investment limit under PPF was not raised. Keeping in view the tenor of PPF and the need to reduce the ALM mismatch of NSSF, the Committee recommends an upward revision in the investment limit to Rs. 1 lakh. The Committee is, however, aware that the current provisions permitting premature withdrawal/taking advance against deposits is not in sync with the objectives of the scheme. More importantly, it is not considered practicable to monitor the end use of the funds withdrawn prematurely. Keeping in view the above considerations, the Committee, therefore, recommends that the rate of interest on advances against deposits may be fixed at 2 percentage points higher than the prevailing interest rate on PPF (as against 1 per cent at present).
The Committee noted the observations made on savings certificates, viz., KVP and NSC by the Rakesh Mohan Committee that both these instruments are quite expensive in terms of the effective cost to the Government and should be discontinued. The Committee is, however, of the view that while KVP may be discontinued as it is prone to misuse being a bearer-like instrument, NSC could continue with the following modifications: (i) Two NSC instruments would be available with maturities of 5 years and 10 years; (ii) The interest rates would be benchmarked to 5 year and 10 year Government securities; and (iii) income-tax exemption under section 80C on accrued interest would not be available. Since income-tax exemption under section 80C on deposits under NSC would be available, NSC may not be encashed before maturity. NSC would, however, continue to be eligible as collateral for availing loans from banks, as hitherto.
Benchmark and Spreads for various instruments
The benchmarks for the various instruments are recommended to be as in Table 1. As regards the spread, the Committee recommends a positive spread of 25 basis points, vis-à-vis Government securities of similar maturities. Exceptions are recommended only in case of 10-year NSC and SCSS as under:
l The Committee notes that NSC cannot be withdrawn before maturity, which affects its liquidity. Keeping in view the longish tenor of the 10-year NSC and the absence of liquidity, the Committee favours a higher illiquidity premium of 50bps (instead of 25 bps as in the case of other instruments).
l As regards SCSS where the rate of interest is currently fixed at 9 per cent, the Committee recommends a spread of 100 basis points over and above the secondary market yield of Government securities of similar maturity.