"This is another assault on the middle class by PM Modi," said Congress Vice-President Rahul Gandhi when interest rates on the Public Provident Fund (PPF) and other popular small savings schemes were cut last week. Clearly, he has not been fully briefed by his own team on this matter.
In November 2011, during (then-finance minister, now President) Pranab Mukherjee's tenure small savings rates were freed from administrative control and aligned with the Government securities (G-Secs) rate of similar tenure. For example, the rate of interest on PPF was fixed from year-to-year, based on 10-year G-Sec yield plus 25 basis points. The PPF rates were changed from 8.6 per cent in November 2011 to 8.8 per cent in April 2012 to 8.7 per cent (April 2013), re-iterated at 8.7 per cent in April 2014 and in April 2015, before being cut to 8.1 per cent in March 2016.
In effect, the rate for PPF did not change at all for the past three years despite the last revision in 2015 being announced by the NDA government. That was not because there was a political consensus in favour of keeping the interest rate on small savings high but because the 10-year G-secs yield was consistently high at around 8.4 per cent a year. This year, this yield has dropped to 7.85 per cent a year and thus the new rate has automatically adjusted to 8.1 per cent.
The only criticism one can make of this reduction is the lack of transparency on how exactly the formula is worked out. The benchmark is the 10-year G-Sec yield declared by FIMMDA (Fixed Income Money Market and Derivatives Association of India). This benchmark is not publicly available. It is also not absolutely clear how the spread of 25 basis points is being used, as well as the rounding-off formula that is being followed.
A quick back check from 2011 onwards, based on benchmark data from Bloomberg, and the calculations are more or less correct, except for rounding off differences of around 0.10 per cent a year. Because of the lack of transparency, it is not possible to know whether or not the finance ministry bureaucrats have played with the formula only to give or take that extra 0.10 per cent a year. The impact of changing the rounding-off basis can be as much as 0.20 per cent, if rounded up in one period and rounded down in the next. This can be quite significant.
But, the Congress can hardly complain about this lack of absolute transparency because it has been happening from their time. The interest rate is likely to head downwards for the next quarter as the yield has dropped further in March 2016 and is expected to drop further in April and May.
It would, thus, be good for the finance ministry to get FIMMDA to disclose the 10-year G-Sec yield rate (as well as the five-year yield used for senior citizen savings schemes and postal MIS) on a regular basis. The ministry should also publicly reveal the exact method by which the spread has been applied, so that people can figure out the rate that will be available from July 1, 2016.
The ministry notification can then be a mere formality and they will not really have to defend charges of being anti-middle class. Of course, the ministry will be able to do all this, provided the bureaucrats in the past have refrained from changing the rounding-off formula to suit the requirements at that time. Will the finance ministry take up this challenge to be absolutely transparent?
The writer is a Securities and Exchange Board of India-registered investment advisor
In November 2011, during (then-finance minister, now President) Pranab Mukherjee's tenure small savings rates were freed from administrative control and aligned with the Government securities (G-Secs) rate of similar tenure. For example, the rate of interest on PPF was fixed from year-to-year, based on 10-year G-Sec yield plus 25 basis points. The PPF rates were changed from 8.6 per cent in November 2011 to 8.8 per cent in April 2012 to 8.7 per cent (April 2013), re-iterated at 8.7 per cent in April 2014 and in April 2015, before being cut to 8.1 per cent in March 2016.
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In effect, the rate for PPF did not change at all for the past three years despite the last revision in 2015 being announced by the NDA government. That was not because there was a political consensus in favour of keeping the interest rate on small savings high but because the 10-year G-secs yield was consistently high at around 8.4 per cent a year. This year, this yield has dropped to 7.85 per cent a year and thus the new rate has automatically adjusted to 8.1 per cent.
The only criticism one can make of this reduction is the lack of transparency on how exactly the formula is worked out. The benchmark is the 10-year G-Sec yield declared by FIMMDA (Fixed Income Money Market and Derivatives Association of India). This benchmark is not publicly available. It is also not absolutely clear how the spread of 25 basis points is being used, as well as the rounding-off formula that is being followed.
A quick back check from 2011 onwards, based on benchmark data from Bloomberg, and the calculations are more or less correct, except for rounding off differences of around 0.10 per cent a year. Because of the lack of transparency, it is not possible to know whether or not the finance ministry bureaucrats have played with the formula only to give or take that extra 0.10 per cent a year. The impact of changing the rounding-off basis can be as much as 0.20 per cent, if rounded up in one period and rounded down in the next. This can be quite significant.
But, the Congress can hardly complain about this lack of absolute transparency because it has been happening from their time. The interest rate is likely to head downwards for the next quarter as the yield has dropped further in March 2016 and is expected to drop further in April and May.
It would, thus, be good for the finance ministry to get FIMMDA to disclose the 10-year G-Sec yield rate (as well as the five-year yield used for senior citizen savings schemes and postal MIS) on a regular basis. The ministry should also publicly reveal the exact method by which the spread has been applied, so that people can figure out the rate that will be available from July 1, 2016.
The ministry notification can then be a mere formality and they will not really have to defend charges of being anti-middle class. Of course, the ministry will be able to do all this, provided the bureaucrats in the past have refrained from changing the rounding-off formula to suit the requirements at that time. Will the finance ministry take up this challenge to be absolutely transparent?
The writer is a Securities and Exchange Board of India-registered investment advisor