New Delhi: The government slashed interest rates on small savings schemes, including public provident fund (PPF) and Kisan Vikas Patra (KVP), to align them with market rates, a move that may facilitate further rate cuts by the central bank and commercial banks.

The revised interest rate on PPF will be 8.1% starting 1 April against 8.7% now. The interest rate on one-year time deposit has been reduced drastically to 7.1% from 8.4%. The interest rate paid by the government on KVP, which matures in 110 months, has been cut to 7.8% from 8.7% till 31 March.

The revised interest rates will be applicable for the first quarter (Q1) of the next fiscal year.

Banks have complained that higher interest rates on small savings have prevented them from cutting their deposit and lending rates substantially.

The government’s latest decision will allow banks to pass on policy rate cuts by the central bank and bolster economic growth.

It’s a signal for banks to cut interest rates but a problematic development for investors who have fewer avenues to save money, said Suresh Sadagopan, founder of Ladder7 Financial Advisories, a financial planning and advisory firm.

“With 7.5-8% savings rates, the real returns after factoring in inflation will be minuscule. Investors have to take some risk and invest part of their money in equities for higher returns," he added.

Sadagopan said PPF still remains attractive for investors even after the interest rate cut, considering it is tax-free.

What came as a surprise, however, is the government’s decision to cut interest rates on savings schemes with a social objective such as Sukanya Samriddhi account, Senior Citizens Savings Scheme and Monthly Income Scheme.

The government only maintained the spread for such schemes. In a press statement on 16 February, the finance ministry had said it will retain both spread and interest rates of such schemes “based on laudable Social Development or Social Security Goals".

On Friday, the finance ministry said in a statement that the additional spread for these schemes are 25 basis points (bps) for PPF, 100 bps for Senior Citizen Savings Scheme, 75 bps for Sukanya Samriddhi Scheme, 25 bps for five-year time deposit, 25 bps for National Savings Certificate (NSC) and 25 bps for Monthly Income Scheme.

A basis point is one-hundredth of a percentage point.

Tapan Sen, a Rajya Sabha member representing the Communist Party of India (Marxist), said the government wants to direct the common man’s savings from the developmental channel to the speculative channel. “This government is pro-capital market, and wants the common man’s savings to go to stock exchanges. They tried to do this with Employees’ Provident Fund (EPF) in round one and when they failed, now they have cut the interest rate on all the small savings schemes because they are directly governed by the finance ministry," he added.

Sen, who is also the general secretary of the Centre of Indian Trade Unions, blamed the Narendra Modi government for indirectly helping the insurance and mutual fund industry by cutting interest rates on small savings and cautioned that such a move will lead to a political backlash in the forthcoming state elections.

In the budget 2016-17, the Union government for the first time had made 60% of EPF withdrawal at retirement taxable. Before 29 February, EPF was a completely tax-free retirement savings product. But after the budget announcement and subsequent backlash from the salaried class, finance minister Arun Jaitley withdrew the EPF tax proposal on 8 March.

The government announced last month that it will review small savings interest rates every quarter instead of an annual review based on the yields of government bonds of the previous three months.

The move is expected to allow banks to pass on policy rate cuts by the central bank through lower lending rates.

While the Reserve Bank of India has cut policy rates by 125 bps in the past year, banks have lowered lending rates only by 70 bps. With lower inflation rate and government sticking to the fiscal consolidation road map, there are now better chances of the central bank cutting policy rates in its monetary policy review on 5 April.

Congress spokesperson Randeep Surjewala said the cut in small savings rates is a criminal breach of trust for the hapless people who have put their money in the custody of the government of India with the belief that they will not be cheated.

“The Narendra Modi government seems hell-bent on fleecing the ordinary poor, middle and lower middle class of the country," he added.

A senior Bharatiya Janata Party leader speaking on condition of anonymity said the government has to sometimes take tough decisions. “We will discuss the issue with the ministers concerned during our regular interactions with the ministers and representatives of the government," he added.

Pretika Khanna and Anuja contributed to this story.

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