SHYAMALA GOPINATH REPORT ON SMALL SAVINGS AND NATIONAL SMALL SAVINGS FUND

BACKGROUND

-          Committee formed on recommendation of the Thirteenth Finance Commission in July 2010 under chairpersonship of Shyamala Gopinath (Dep. Governor, RBI) and 6 other members
-          Mandate -  comprehensive reforms in overall administration of National Small Savings Fund (NSSF)
-          Terms of Reference include
a)      review of the existing small saving schemes in operation and recommend mechanisms to make them more flexible and market linked;
b)      review of the existing terms of the loans extended from the NSSF to the Centre and States and recommend on the changes required in the arrangement of lending the net collection of small savings to Centre and States
c)       review of the other possible investment opportunities for the net collections from small savings and the repayment proceeds of NSSF loans extended to States and Centre
d)       review of the administrative arrangement including the cost of operation
e)       review of the incentives offered on the small savings investments by the States.
-          The committee approach to small savings reforms  has emanated both from angle of  1) Private investors/savers and 2) Public finances of Central and Sate Govt
 
 
KEY RECOMMENDATIONS
 
1. Committee recommends closure of only one existing scheme – the Kisan Vikas Patra (KVP) while recommending continuation of all other schemes with suitable modifications. Closure of KVP which at times is illegitimately used for Money Laundering.
However, currently KVP accounts for a large share of small savings (25%)
 
2. Recommends linking interest rate of small savings schemes to some well known benchmark rates such as yields on Govt securities of comparable maturities.
 
-          Interest rate to be revised annually (The administered rates may be notified by the Government every year on April 1, effective 2012) and a cap of 100 basis points should be placed so that the administered rates are neither raised nor reduced by more than 100 basis points from one year to the next, even if the average benchmark interest rates rise or fall by more than 100 basis points. This would reduce the year-to-year volatility in the administered rates.
 
-          However, interest on Post office Savings Bank deposit will continue to be administered, but will entail 4% as against 3.5 % earlier
 
This step will entail following positives:
a)      greater transparency in interest rates
b)      more cost-effective management of public finances at the Central and State levels
c)       Revive interest of investors who have been off lately migrating to banks which offer higher deposit rates (than current administered int. rates on small savings scheme). This is esp. important in view of the recent deregulation of bank deposit rates by RBI
 
d)      Revive the declining small savings collections which are a source of govt borrowing. The govt had recently announced an additional borrowing of Rs. 53, 000 cr to make up for shortfall in small savings collections. Such steps can be avoided in future.
 
3. Recommends strict enforcement of KYC norms to prevent money laundering/generation of black money. The computerization and the introduction of CBS (core banking solutions) linking all post offices. In its absence it is possible for individuals to avoid the ceiling on various instruments by parking their savings across more than one branches (thus putting more financial burden on govt)
 
4.       Rationalisation of Small savings Instrument – for more flexibility and greater returns to Savers/investors
 
a)       Post office Savings Deposit – rates to be increased from 3.5% to 4% pa
b)      5 year recurring deposit scheme – Lock in period to be reduced from current 3 yrs to 1 year, reducing penalty rate on premature withdrawal, reducing commissions to agents.
c)       Postal Time deposits – depositosr given the option to close the deposit before maturity.  In case of premature withdrawal with 6-12 month interest rate equivalent to savings deposit be paid (as against nil currently). Interest rate to be aligned to market rates. Int will not be tax free
d)      Monthly Income Scheme – Maturity Bonus to be abolished and interest rate to be aligned to market rates. Reduction in Maturity to 5yrs from current 6 yrs. No tax benefits and int. income is taxable.
e)      Senior Citizens’ Savings Scheme (SCSS) – No Change. Will continue to offer 9 per cent for investment up to Rs.15 lakh
f)       Public Provident Fund (PPF) – Increase ceiling on investment in PPF from Rs. 70,000 to 1,00,000 with claim tax rebate under Section 80C of the Income Tax Act. PPF deposits to carry an interest of 8.60 per cent instead of 8 per cent.
g)      Savings Certificates
Kisan Vikas Patra – to be discontinued as it is prone to be misused for money laundering and expensive for Govt in terms of effective cost National Savings certificates – (i) Two NSC instruments would be available with maturities of 5 years and 10 years; (ii) The interest rates would be benchmarked to 5 year and 10 year government securities; and (iii) income tax exemption under section 80C on accrued interest would not be available. Since income tax exemption under section 80C on deposits under NSC would be available, NSC may not be encashed before maturity, higher rate of interest to be provided given the higher illiquidity  
5.       INVESTMENT OF NATIONAL SMALL SAVINGS FUNDS (NSSF)
 
About NSSF – All deposits under small savings schemes are credited to NSSF and all withdrawals by the depositors are made out of accumulations in the Fund.
a)      Income of NSSF – consists of interest receipts on the investments by NSSF in Central Govt (Special Central Govt Securities - SCGS), State Government (Special State Govt Securities - SSGS) and other securities.
b)      Expenditure of NSSF - The expenditure of NSSF comprises interest payments to the subscribers of Small Savings and PPF Schemes and the cost of operating the schemes, also called management cost (includes salary, payment of commissions to agent, payment of agency charges to Postal Dept. )
c)       Investment by NSSF - NSSF invests the net collections of small savings in the special State Government securities (SSGS) as per the sharing formula decided by the Government of India. The remaining amount is invested in special Central Government securities (SCGS) with the same terms as that for the States. These securities are issued for a period of 25 years, including a moratorium of five years on the principal amount. Rate of interest is 9.5% (from govt). NSSF is also permitted to invest in IIFCL @ 9%
d)      Problems of viability of NSSF – 
1)      Negative Mismatch between Income and Expenditure because
-       Even though income earned by NSSF by way of interest on loans extended to Central/State Govt (9.5%) is more than NSSF expenditure by way of interest paid to the small savings instrument holders, the interest earned by NSSF on reinvestment of redemption proceeds is low. Therefore the OVERALL rate of return on assets (ie. Int received on investment plus reinvestment by NSSF) is less than the total cost (interest cost and cost of operation paid by NSSF), the NSSF has been incurring losses in the past. Hence the Gap.
-       The resetting (reducing) of the interest rates on SSGS and SCGS without a corresponding decline in the interest rates on the liabilities (int. on small savings payable by NSSF) side also contributed to the negative spread. This is further exacerbated in view of 13th Finance commission’s recommendation o f reducing int rate on SSGS to 9% (from 9.5%)
-       High Management Cost adds to expenditure
2)      Asset – Liability mismatch
-       The average duration of the small savings schemes is around 6 years whereas the maturity period of loans to States is for 25 years. Hence the mismatch
 
Since Revenue - expenditure deficit has to be filled in by refinancing from Govt, the assets- liabilities gap has increased due to increase in liabilities of NSSF.  
 
All this is leading to eroding asset base coupled with low return on investment by NSSF. And since the asset base is lower than the liabilities, the income in absolute terms is even lower. Over the years, this has become a vicious cycle
Were NSSF to become unsustainable, the ultimate fiscal costs would devolve on the Centre. As a result Centre will engage in greater borrowing from market, further exacerbating the fiscal deficit.
 
Recommendations for maintaining viability of NSSF
Cost of operation (Management cost) of NSSF should be kept under control esp the Agency charges and commission to the agents should be phased out (in case of agents under Mahila Pradhan Kshetriya Bachat Yojna it should be reduced to 1% from 4%) Reduce the time lag between receipts of small savings and their investments to atmost 1 month Rate of re- investment should be brought at par with rate of fresh investment. Downward resetting of interest rates on the assets side (ie return on investment by SSCG/SSGS) may not be henceforth considered without regard to the viability of the NSSF and/or corresponding reduction of interest rates on the liabilities side (ie. Int paid on small savings )
Reduce the tenor mismatch between the assets and the liabilities of NSSF. This may be achieved by reduction in the maturity of SSCG/SSGS (currently 25 yrs) to 10 years  the return on SCGS should be brought at par with the return on SSGS and recapitalization of NSSF may be undertaken by Centre to bridge the gap between assets and liabilities of the Fund Allowing NSSF to invest in infrastructure companies owned by Govt eg. IIFCL, NHAI