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Home > Business > Business Headline > Report

Big decisions on small savings

P Vaidyanathan Iyer | February 18, 2003 13:57 IST

In the run-up to Budget 2003, one of the key decisions Finance Minister Jaswant Singh will have to take concerns the small savings schemes.

With just 18 months to go for the next general elections, will Singh bite the bullet by reducing the tax rebate on investments in small savings instruments? Will he pare the interest rates they offer?

The indication available now is that Singh will do neither. He may merely reduce the tax rebate.

There are, however, enough compelling reasons why the finance minister should do both, even if his party has equally strong political reasons for doing neither.

Current investments in small savings instruments are eligible for 15 per cent tax rebate for individuals in the Rs 150,000 to Rs 500,000 annual income bracket. The annual interest rate that the government offers on these instruments averages 9 per cent.

First, consider the interest rate. The soft interest rate regime has ensured that the government can now borrow at rates as low as 6 per cent.

In fact, the weighted average cost of government borrowings in the current fiscal, according to leading primary market dealer PNB Gilts, is 7.18 per cent, a sharp drop of over 200 basis points from 9.44 per cent in 2001-02.

Also, the real interest rate on small savings (interest rates minus inflation) has probably been the highest during the last three years, ever since the BJP-led National Democratic Alliance came to power in October 1999.

This is due to the low inflation rates in the last three financial years at 4, 6 and 5 per cent, respectively. And in the current fiscal, it has been about 4 per cent.

The low inflation rate has ensured that the real interest rate on Post Office Monthly Income Account Scheme, one of the most popular schemes with individual investors, was as high as 8.83 per cent in 1999-2000 and 7.1 per cent this year.

For National Small Savings Certificates, it was 7.23 per cent in 1999-2000 and is 5.68 per cent now. This year's real interest rate on these instruments has been calculated assuming the average WPI-based inflation rate at 3 per cent.

The government had reduced the interest rate on small savings from 9.5 per cent to 9 per cent in Budget 2002. But with the yield on the benchmark 10-year paper sharply dropping by over 200 basis points during the first 10 months of 2002-03, there is a strong rationale for paring the rate further.

Second, consider the tax exemption available to individual investors. In Budget 2002, finance minister Yashwant Sinha had halved the rebate available on investments in small savings to 10 per cent from 20 per cent earlier. After a public outcry, he rolled it back partially and increased the rebate to 15 per cent.

Realistic estimates by the finance ministry indicate that the income foregone owing to the tax rebate is as high as Rs 8,000 crore (Rs 80 bilion)if not more.

A five percentage point reduction in the tax rebate would release as much as Rs 3,000 crore (Rs 30 billion). And, it is the individual in the Rs 1.5 lakh to Rs 5 lakh annual income category who makes the most of such rebates.

Data from the revenue department also reveals that three-fourths of the total number of taxpayers fall in the annual income bracket below Rs 1.5 lakh. That being the case, the core of the middle-class of the BJP's vote bank hardly stands to lose if the tax rebate is withdrawn.

If the mop-up from small savings this year is any indicator, then neither a cut in the interest rate nor a dilution in the tax rebate has had any adverse impact. While the budget estimate for collections from small savings is Rs 40,000 crore (Rs 400 billion), the government has already mopped up over Rs 37,500 crore (Rs 375 billion).

Typically, the last two or three months raked in the most since people tend to keep their tax planning to the last. So it is quite likely that the estimate would easily be exceeded.

If the government is worrying that such a move will curb savings, then facts do not indicate that realisation is lower due to a rate cut. If it is concerned that the middle class would be adversely affected, then too, it is largely the Rs 3 lakh plus income category that invests in such instruments.

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