Small saving schemes remain good options as RBI retains status quo on interest rate

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While announcing the monetary policy, Reserve Bank of India Governor, Shaktikanta Das reiterated that the accommodative stance would continue along with the ‘whatever it takes’ attitude to push growth. Interest rates were left unchanged but the expected inflation was higher at 5.7% for the current fiscal against 5.1% projected in June 2021. Inflation, along with the 5:1 split vote in favour of accommodative stance and increase in variable reverse repo rate auctions is making many feel that a hawkish RBI stand is in the offing.

Experts say that there could be a phase of gradual withdrawal of liquidity. What would all this mean for interest rates on small saving schemes (SSS) and investors?

SSS rates attractive

SSS are a fundraising tool for the Government and the interest rate on offer has political ramifications. Despite massive cuts in interest rates in recent times, the rates payable on SSS were not reduced with the same intensity. On March 31, 2021 the rates on SSS were cut, but were reversed in no time.

SSS score far higher than most other comparable fixed income instruments. For example, a five-year National Saving Certificate (NSC) offers 6.8% annually compared to 5.4% offered by State Bank of India five-year fixed deposit. HDFC offers 6.4 percent for a five-year FD.

The SSS, including NSC are offering a positive real rate of interest. Real rate of interest is arrived at by deducting nominal rate of interest minus inflation. At a time when most other fixed income instruments are offering negative real returns, SSS is a far more attractive option. PPF and Sukanya Samriddhi Yojana also offer tax free returns.

“Small savings schemes are a good option for retail investors especially when the government is keeping small saving rates much higher than market interest rates. However, investors should be mindful of the illiquidity associated with these schemes and allocate accordingly,” Pankaj Pathak, Fund Manager, Fixed Income, Quantum AMC, said.

Will SSS offer a higher rate?

Government will be in no hurry to increase the rate of interest on small savings. It not only increases the interest outgo and also makes other fixed income options such as government securities less attractive. Also the interest rates offered on Reserve Bank of India Floating Rate Bonds (FRB) are linked to NSC (it pays 35 basis points more than the rate of interest available on NSC). Any increase in rates of NSC will inflate the interest bill on all RBI FRBs.

Investors hence should not wait for the rates to go up. Investing in the short end of the yield curve – say in one year fixed deposits deprives you of the higher coupon offered by NSC. It makes sense to look at NSC and pocket the higher rate of interest. Even if the interest rates go up marginally on fixed deposits one year from now, they are unlikely to bridge the existing gap.

Liquidity a concern

Investors must be aware that SSS schemes suffer from lack of liquidity and must plan their investments accordingly. “The big disadvantage of SSS is their lock-in periods. For example, POMIS (post office monthly income scheme), has a lock-in of 5 years. This doesn’t help in the rising interest rate scenario. If one would like to take a little risk, they can choose to invest in dynamic bond funds which manage the duration,” S Sridharan, Founder, Wealth Ladder Direct said.

However, if liquidity permits, then you can go for NSC and other SSS. If you are still worried about interest rate movements, then consider laddering in NSC by investing at regular intervals. This locks-in money for five years and you get the rates prevailing then. You also get cash inflows at intervals as maturities are spread out accordingly. For example, if you buy an NSC each quarter, then the maturities also line up at the end of each quarter at the end of five year onwards.