Fixed Income: Locked in small savings schemes till the end of June

Since April 2016, interest rates on small savings schemes have been aligned with spreads with government security rates of similar maturity.

Risk-averse investors can now invest in small savings schemes as the government may cut interest rates from July 1. In fact, on May 31, the government drastically reduced interest rates on all schemes in line with the rates of government securities, but withdrew the notification the next day in view of assembly elections in many states.

Small savings schemes are popular among fixed income investors as they offer much higher interest rates than bank fixed deposits. Data from Reserve Bank of India (Reserve Bank of IndiaThe share of small savings in household financial savings increased 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In the withdrawn notification, the interest rate for Public Provident Fund (PPF) was reduced from 7.1% to 6.4%; 5-year fixed deposit 6.7% to 5.8%; Senior Citizen Savings Scheme (SCSS) 7.4% to 6.5%; Monthly Income Scheme (MIS) from 6.6% to 5.7%; National Savings Certificate (NSC) 6.8% to 5.9%; Kisan Vikas Patra (KVP) from 6.9% (138 months duration) to 6.2% (124 months duration) and Sukanya Samriddhi Yojana (SSY) from 7.6% to 6.9%.

Experts say that the government may cut the rates of small savings from July 1 as interest rates have come down in the economy. Reducing interest rates would be in line with the strategy of the RBI and the government to boost consumption and revive the economy as GDP contracted 7.3% in FY21. Since April 2016, interest rates on small savings schemes have been aligned with spreads with government security rates of similar maturity.

Lock in higher rates
Investors can lock in post office fixed deposits of 1, 2, 3 and 5 years, NSC, KVP, 5 years recurring deposit, MIS and SCSS at higher interest rates for the entire tenure of the investment. When interest rates are revised, these schemes pay contracted rates till maturity. However, in case of PPF or SSY, the entire balance amount will be earned at the revised rates.

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

The minimum deposit in KVP is Rs 1,000 and in multiples of Rs 100. However, there is no maximum investment limit. The maturity period is determined by the Ministry of Finance which is applicable on the date of deposit. KVP can be closed prematurely subject to certain conditions.

PPF remains the most popular
PPF remains the most sought-after investment option for building a tax-free nest egg. The tenure of the account is 15 years and can be extended for a block of 5 years. A customer can make a 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 the balance on credit at the end of the previous fourth year or at the end of the previous year, whichever is less.

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 will be deducted from the date of account opening/extension date, as the case may be.