Fixed income: Lock in small savings schemes by June-end

The government is likely to reduce the interest rates on small savings schemes from July 1 to keep in line with falling interest rates in the market

Risk-averse investors may invest in small savings schemes now as the government is likely to reduce the interest rates from July 1. In fact, on May 31, the government drastically reduced the interest rates on all the schemes in line with government securities rates but withdrew the notification the next day, given the Assembly elections in several states.

Small savings schemes are popular with fixed income investors as they offer much higher interest rates than bank fixed deposits. Data from Reserve Bank of India (RBI) show share of small savings in household financial savings grew from 1.3% of GDP in Q3FY20 to 1.4% in Q3FY21.

In the withdrawn notification, the interest rate for Public Provident Fund (PPF) was reduced to 6.4% from 7.1%; 5-year term deposits to 5.8% from 6.7%; Senior Citizens Savings Scheme (SCSS) to 6.5% from 7.4%; Monthly Income Scheme (MIS) to 5.7% from 6.6%; National Savings Certificate (NSC) to 5.9% from 6.8%; Kisan Vikas Patra (KVP) to 6.2% (124 months duration) from 6.9% (138 months duration) and Sukanya Samriddhi Yojana (SSY) to 6.9% from 7.6%.

Experts say the government may reduce the rates of small savings from July 1 as the interest rates in the economy have fallen. Lowering the interest rates will be in line with RBI’s and the government’s strategy to boost consumption and revive the economy as gross domestic product contracted 7.3% in FY21. Since April 2016, interest rates on small savings schemes are aligned with the government security rates of similar maturity with a spread.

Lock in at higher rates

Investors can lock in at higher interest rates in 1, 2, 3 and 5-year post office term deposits, NSC, KVP, 5-year recurring deposits, MIS and SCSS for the entire duration of the investment. When interest rates are revised, these schemes pay the contracted rates till maturity. However, in case of PPF or SSY, the entire balance will earn the revised rates.

Schemes such as NSC, KVP and MIS are ideal ladder investments which can be used for various financial goals. You can also buy NSC from public sector banks and a few private sector banks and pledge the certificates as collateral for loans from banks or non-banking financial institutions. The corpus—principal and interest earned—is paid to the investor at the time of maturity. While no TDS is deducted, you have to pay tax on the interest earned at your marginal rate.

In KVP the minimum deposit is Rs 1,000 and in multiples of Rs 100. However, there is no maximum limit for investment. The maturity period is prescribed by the ministry of finance as applicable on the date of deposit. One can prematurely close a KVP subject to certain conditions.

PPF remains most popular

PPF remains the most sought-after investment option to create a tax-free nest egg. The tenure of the account is for 15 years and can be extended for a block of 5 years. A subscriber can make one withdrawal during a financial year after five years excluding the year of account opening. The amount of withdrawal can be taken up to 50% of balance at the credit at the end of fourth preceding year or at the end of preceding year, whichever is lower.

Premature closure is allowed after five years from the end of the year in which the account was opened subject to certain conditions. At the time of premature closure 1% interest shall be deducted from the date of account opening/date of extension as the case may be.