Small savings, big problems

The National Small Savings Organisation (NSSO) operates a variety of schemes "" the Public Provident Fund, the National Savings Scheme and others run through the post office network "" which provide an important channel for long-term savings for individuals.

The entire amount raised through these channels is passed on to states. The NSSO raises funds at a cost of roughly 8 per cent per annum and lends them to states at 9.5 per cent, the mark-up being justified by costs of collection.

Each state is entitled to borrow from the pool to the extent of resources mobilised by it. In 2005-06, the Union Budget estimates net lending to states of Rs 87,000 crore; not a small amount by any means.

But, given the interest rate scenario in the country today, 9.5 per cent looks like a rather high price to pay for funds and states are, therefore, reluctant to draw their entitlements.

If this stand-off persists, the central government will have to service its obligations to savers without a corresponding flow of interest income from the states.

This is clearly an untenable outcome and needs to be addressed at two levels. From a short-term perspective, the centre must ensure that it is at least able to cover its interest obligations to savers so that they do not turn into deficit-busters.

In the long-term context, the distortions inherent in the scheme need to be addressed.

The immediate requirement clearly warrants a reconsideration of two parameters of the scheme.

Given current market conditions, when many states can apparently borrow in the 7-8 per cent range, it does not make a lot of sense to force 9.5 per cent borrowings down their throats.

The Centre needs to significantly reduce the mark-up to a more realistic number. The other change required is to create a secondary market between states for the entitlements.

If a state with a high entitlement feels it can get funds from the market at a lower rate, it should be free to lend what it does not want to other states for whom market borrowing is a relatively expensive (or unavailable) proposition.

Both these measures should contribute to a larger appetite for these funds amongst states and thus allow the Centre to meet its obligations.

From a longer-term perspective, if states were to be subject to genuine market forces, most if not all would find it difficult to borrow at the rates being perceived today.

Their access to low-cost funds is the result of various interventions, explicit and implicit, by the central government and the Reserve Bank of India.

Rapid and dramatic fiscal reforms over the next couple of years will put a few states within reach of the market under their own steam. In a genuine market environment, a reasonable mark-up over 8 per cent may still be the most economical source of borrowing for states.

If they want to find better deals, they will have to revamp their finances first.