Are market-linked small savings attractive?

After months of deliberation on the recommendation of the Shyamala Gopinath committee, which was constituted to comprehensively review various parameters of the National Small Savings Fund (NSSF), the government on Friday accepted most of them. Here is what your small savings will look like now.

Market-linked returns
One of the most significant recommendations was making the returns of small saving schemes market-linked and that is now a reality. From this financial year, the rates for small saving instruments will be benchmarked to those of government securities (G-secs) of similar maturity periods with a positive mark-up of 25 basis points (bps). However, for Senior Citizen's Savings Scheme (SCSS), the mark-up is 100 bps and for the new National Savings Certificate (NSC) with a tenor of 10 years, the mark-up is 50 bps.

So if a 10-year G-sec yields 8%, then the rate of interest for Public Provident Fund (PPF) would be 8.25%, 8% plus a mark up of 25 basis points. The government would notify the interest rates applicable for the year on various instruments before April 1 every year.

Structural changes
PPF: The investment ceiling for PPF has been increased from Rs 70,000 to Rs 1 lakh. So for the current financial year, FY12, you can pump in an additional Rs 30,000 if you have already invested the maximum. The entire Rs 1 lakh will qualify for deduction under section 80C of the Income-tax Act.

However, the interest on loans from PPF has been increased from 1% to 2% per annum.

Post office time deposits: In order to make postal time deposits more liquid, the guidelines have allowed premature withdrawals. However, the rate of interest applicable on premature withdrawals would be a percentage point less than what is offered on a deposit of comparable maturity. For example, if you have a five-year time deposit and you wish to withdraw your corpus after two years, the rate of interest will be that applicable on a two-year time deposit minus a percentage point.

Others: The government has also squeezed the tenors of Monthly Income Scheme (MIS) and NSC from six years to five years and has introduced a new NSC with a maturity of 10 years. Kisan Vikas Patra has been discontinued.

The returns you should expect this year

You have a reason to cheer this year. Owing to a rising interest rate scenario, market-linked returns will have a positive or no impact on the current rates given by various small saving instruments.

PPF will see the return increase by 60 bps to 8.6%. For SCSS, there has been no change and it will continue to fetch 9% this year. In case of MIS, you gain some and lose some. MIS would provide you an interest of 8.2% per annum as compared with 8% earlier, but you will no longer get 5% bonus at the time of maturity. If you have invested in NSC, you will get 8.4% as compared with 8% earlier.

You would also get an additional interest of 50-145 bps during the current financial year on term deposits of various maturity periods. The biggest increase has been for one-year term deposits from 6.25% earlier to 7.7%.

What it means for you?
With the government deciding to move to market-linked rates on all small savings instruments, the interest you get may vary each year.

Even till now, the government had the flexibility of offering different rates at different points of time, but that has not been the case. Instruments such as PPF, NSC and SCSS have provided more or less stable interest rates for years now. For instance, PPF has been giving 8% for about eight years.

But all that is going to change and now rates would vary every year depending on G-secs yields. Generally, G-secs yields rise in a tighter liquidity environment and fall in case of ample liquidity. The interest would also depend on the Reserve Bank of India. In a high interest rate regime, yields on G-Secs are higher and are lower during low interest rate regime.

However, even under the flexible interest rate regime getting an indication of returns wouldn't be to difficult.

Though the rates have become dynamic, our investment advice with respect to the two most popular investment vehicles from the stable of NSSF-PPF and SCSS-doesn't change. They remain attractive investment vehicles in the long term for post-retirement income. For your debt investments you could still consider these vehicles, but you can alter the investment amount each year depending upon the interest rate movements.