Small saving is one of the favourite whipping boys in debates on bank deposit rates in our country. Indeed, one of the first factors cited in explaining bank deposit rates structuring is the ‘important’ role played by interest rates on small savings products viz. postal deposits, savings certificates such as the NSC and the Vikas Patras as well as the public provident fund (PPF).

Be it the monetary policy statement of the Reserve Bank of India or the explanation offered by a commercial bank CMD, there would be copious reference to the interest rates on small savings products as having an important influence on the level of bank deposit rates, if not the direction itself. Of course, the bank CMD falling back upon small savings’ interest rates to explain his deposit interest rates moves can be well understood given that the lead is given by the central bank itself.
Sample this from the January and April 2009 monetary policy statements of the RBI: “the interest rate response to monetary policy easing has been faster in the money and bond markets as compared to the credit market because of several structural factors. First, the administered interest rate structure on small savings could potentially constrain the reduction in deposit rates below some threshold.” The RBI was seeking to explain in its policy statement why bank deposit rates had not (and still have not) declined as much as policy makers would have preferred on the back of the substantial easing in the central bank’s reference interest rates as well as the flood of liquidity created by it in the past six months through various market operations.

Substantial monetary easing not trickling down

The RBI now borrows for the short-term (ie overnight) at 3.5 per cent and lends at 5 per cent. These rates were respectively 6 per cent and 9 per cent in September 2008. Going beyond those cuts in its reference interest rates - which in turn set the level for borrowing / lending rates in the wholesale financial markets - the RBI has also effected deep cuts in the level of cash reserves banks have to hold against their deposits. The RBI is also actively operating in the government securities market to release further liquidity in to the system.

As can be seen, there has been a less than commensurate reduction in bank deposit and lending rates in the face of all the substantial monetary accommo-dation being provided by the RBI. While deposit rates have moved down by around 1 /1.5 percentage points, lending rates too have softened by a similar extent.

And, as noted above, a prime reason cited for this less than proportionate softening in bank deposit (and lending) rates is the stickiness in small savings interest rates. That stickiness in small savings means that bank deposit rates have to be suitably structured so that bank deposits remain competitive vis-à-vis small savings products in attracting household savings, goes the argument.

Small savings rates in line with bank rates

The earnestness with which the foregoing argument is made would make one presume that small savings (SS) interest rates are way above bank deposit rates. But, that is not so as a study of the various SS products shows. Indeed, for the illiquidity inherent in many of the SS products - which means that investors in SS products cannot easily encash their savings in case of need – one can even say that govern-ment is not paying an adequate illiquidity premium, despite the tax benefits some of the SS products offer.

Among the various SS products, the Vikas Patras double the sum invested in about 9 years. That gives a compounded annual interest rate of 8 per cent, certainly not an outsized return in both absolute and relative terms. The rate on the Public Provident Fund is 8 per cent, again not out of tune. On time deposits, post offices offer even lower rates - around the 7.50 per cent levels. The rate is broadly between 7.50 and 8 per cent on the other products also - the NSCs and the monthly income schemes. At this particular point in time, therefore, interest rates on SS products are certainly not out of kilter with bank deposit rates and cannot be considered as more than matching competition. Even over the course of the past few years, when interest rates were gradually rising (from around early 2005), while SS interest rates remained fairly steady, bank deposit rates were catching up from the lows of 2003 and 2004.

(The asymmetry in government’s approach to setting SS interest rates comes out here. When interest rates were falling from early 2000 to 2004, government was even pre-emptive in cutting SS interest rates. The rates on PPF, monthly income schemes, the NSCs and Patras all declined significantly in that period, falling from around the 12/12.5 per cent levels to the 8 per cent mark, at which point they have stood still. But when overall market interest rates began moving up, from early 2005, SS interest rates were not adjusted upwards).

It is difficult to visualize, given the above interest rates structuring, that SS products could be so competitive vis-à-vis bank deposits.

Bank deposits continue to be dominant

That small savings’ influence on the bank deposit rates structure is being overestimated is also evident from a study of the (historical) component wise break up of household financial savings.

As is very clear from the component wise break up, bank deposits have accounted for a dominant share of total household financial savings through the past four decades. Even during the period when the share of small savings increased almost 100 per cent - from 7.1 per cent of total savings to 14.9 per cent between 1996-97 and 2002-03 (ostensibly because of higher rates), it can be seen that bank deposits held their own - rising from 33 per cent of total savings to 39 per cent. Bank deposits’ share has further increased to account for nearly 45 per cent of savings, in the first 7 years of this decade. Against that, small savings now comprise around 17 per cent of household financial savings.

Where is the competition at all for bank deposits from small savings given this track record and historical experience? And why should SS interest rates potentially constrain the reduction in bank deposit rates below some threshold?

Bank deposit rates structuring is not a function merely of the reference interest rates of the central bank. A lot has to do with considerations relating to the liquidity position of a bank and its balance sheet (asset / liability) positioning. Competition, for sure, also plays a notable determining role in interest rates changes even if the liquidity / balance sheet positions may suggest no change is required. But it is clear that competition for Indian banks is from other banks and not SS products.