In the budget this year, one of the significant announcements was that the small savings rates in the various schemes will be aligned to the market rates. From an economic viewpoint this is unexceptional – after all it does not make much sense for the government to pay you more than what the market is offering you on similar instruments, often coupled with a higher level of risk.
However, i was somewhat skeptical with this announcement as similar attempts have been made before and not much had come out of it. In case you follow the annual chaos that often accompanies the fixing of PF rates every year, you will probably get what I am trying to say here. The basic issue is this – there is a very strong constituency which invests in these products and it is not easy to disregard them for any government. Over the years dependence on these products have reduced to some extent, thus making is possible to reduce the rates significantly over time. Nevertheless, it will be quite another matter to make the rates completely market linked without raising a lot of hue and cry.
In the actual event the rates were changed for the first quarter, left untouched for the second quarter and have only been marginally tinkered with in this quarter. So the PPF rates are still 8 % and the SSY rates are at 8.5 %. If you look at these rates being market linked as per the declared policy then we are about 50 basis points higher today. The chances are that the rates will hold for the current FY and further reductions will happen in the April 2017 quarter.
What does this really mean for your investments in schemes such as PPF and SSY? Consider the following :-
- These are part of your debt allocation, so cut out the noise and do not try to compare it ever to equity returns.
- Understand that though the rates will probably not be completely market linked, over the next 2 years or so they are very likely to go down further.
- I feel that PPF rates can go down to 7 % in the next year or so. The SSY rates will generally be 50 basis points higher than the PPF rates.
- 7 % tax free returns on your money is still worth quite a lot. At the highest tax bracket you will need to earn more than 10 % from an instrument whose returns are taxed, in order to match this. There are simply no such instruments.
- If you are not needing income out of your investments, just keeping them where they are makes a great deal of sense.
Remember, these are long term products and will also get benefited by the interest rate cycle. Over the next 5 years or so interest rates will rise again and all your investments earning a tax free return will be a bonanza then. Furthermore in a low inflation regime any real rate of return that is guaranteed along with tax breaks will always make eminent sense. Debt has a specific place in your portfolio, understand and act accordingly.
What are my plans on these schemes? Well, I have a long running PPF account and my wife has restarted her account 3 years back. Till the rates are at 7.5 % levels I plan to keep contributing regularly to it. At the current rates today, we earn sufficiently from it to cover about 50 % of our annual expenses. Assuming we keep investing 3 lacs in it for the next 7 years or so, the income generated from these accounts will probably cover our entire annual expenses at that time.
The only caveat to this is any possible changes in the tax treatment of these schemes. I do not think that is likely, given the difficulties that the government is facing in aligning the rates to the m