Without doubt, it is a very unpopular course to pursue. Yet, the Bharatiya Janata Party-led government has decided to act boldly and slash interest rates on several Centrally sponsored savings schemes. The decision will upset senior citizens, and the salaried middle class that forced the government to reconsider its decision to tax a portion of the Employees’ Provident Fund (EPF) corpus upon withdrawal. The government has also decided to reset these rates every quarter. The objective is to align them with market rates. It has not come all of a sudden: there were enough hints to indicate that the government is not averse to shedding its populist mindset and looking to deal with economic issues from a realistic perspective. For instance, the government has excluded people above an annual income threshold from availing of the subsidy for LPG for household use. And though the government finally abandoned the Budget 2016 proposal to tax EPF, it was a clear indicator of things to come. Viewed in this context, there is a method in the manner in which the government has set out to implement its economic agenda. Its latest action on small savings could yet deliver the unkindest of cuts to its core constituency, the middle class. For, the rate cut covers a broad spectrum of schemes, including the Public Provident Fund (PPF), the Kisan Vikas Patra (KVP) and the National Savings Certificates (NSC). Surprisingly, the cut has also not spared schemes with a larger social intent, such as those for girl children and senior citizens. However, the government has decided to maintain the interest spread on such schemes. The rate cut is bound to emerge as a fresh rallying point for the Opposition to corner the government. These schemes have been a safe bet and offered assured returns for the salaried sections. These are also useful instruments to foster the saving habit among people. You cannot easily wish away the social security concerns thrown up by the rate cut decision, and the government will have to politically defend the cut.
Read in tandem with the U.S. Federal Reserve decision last week to keep its interest rate policy unchanged, the rate cut on the Centrally backed small savings schemes must clear the way for the Reserve Bank of India to lower its policy rates. Though the RBI had slashed its key policy rate by 125 basis points in 2015, banks had been extraordinarily reluctant to pass on the full benefits to borrowers. The deposit mobilisation efforts of the banks have faced unequal competition from small savings schemes, which offer artificially fixed, higher interest rates. That makes it difficult for banks to transmit fully the benefits of rate cuts made by the RBI. The rate cuts on savings schemes represent a necessary course correction to right the distortions in the system. It will also inevitably usher in a competitive cost structure in the economy for the greater public good. The cuts make good economic sense, and the government should stand firm on it.