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Rate Cut in PPF Means No Avoiding Equity? Research Team | Posted On Tuesday, March 22,2016, 06:34 PM

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Rate Cut in PPF Means No Avoiding Equity?



Finally the bad news is out. The Government of India has slashed interest rates offered on the PPF, from 8.7% a year to 8.1% a year. The Government of India has also cut interest rates on other small saving schemes. Finally what you feared has happened.... The Government is sending a stern message to lazy investors like you; No Longer can you invest in small saving schemes and say, Job Done.

What are Small Saving Schemes?

If you invest your money in Public Provident Fund (PPF), NSC, Kisan Vikas Patra (KVP), Senior Citizens Savings Scheme, Sukanya Samridhi Scheme and Post Office Monthly Income Scheme (POMIS), you are investing in small saving schemes.

The Government of India has cut interest rates offered on the PPF (Public Provident Fund), by 60 basis points. (1 basis point is 0.01%). PPF which used to offer you an interest of 8.7% per year, now offers 8.1% per year. This is for the time period of April 1st 2016 to June 30th 2016.The interest rates would be reset every quarter.

What Does a Cut in PPF Rates Mean?

The RBI has cut repo rate from 8% to 6.75%, across the year 2015. The RBI hopes that a cut in repo rates, would force banks to slash base rates, (lowest rate banks can lend). How does this help you? Oh…it means banks lend to you at a lower interest rate. Your loan just got cheaper.

Banks have also cut fixed deposit rates. This means if you invest in a bank fixed deposit, you get a lesser rate of interest. However banks have been reluctant to cut lending rates for borrowers, beyond a point. RBI is disappointed with banks, for not passing the benefit of lower repo rates to borrowers. What do banks have to say about this? Banks believe that if they cut lending rates for borrowers beyond a point, they would also have to cut fixed deposit rates they offer you (customers who invest money in a fixed deposit). Small saving schemes like the PPF, offer a higher interest rate of 8.7% a year. Investors would remove their money from bank fixed deposits and shift it to PPF and other small saving schemes. This forces banks to offer a higher interest rate on fixed deposits and also forces borrowers to pay higher interest rate on loans.

How has the Government responded? It has slashed interest rates offered on the PPF from 8.7% a year to 8.1% a year. Now banks could cut lending rates on your loan and also cut interest rates offered on fixed deposits to customers who invest with them.

The Government tells banks: We have cut interest rates on small saving schemes. It is your turn to cut lending rates and help borrowers avail cheap loans.

See Also: Pradhan Mantri Awas Yojana: How To Choose The Right Home Loan?

Rate Cut in PPF Means No Avoiding Equity

For long you have been investing in PPF and small saving schemes, to collect money for retirement. You were a lazy investor. You got high interest rates from PPF and small saving schemes, of over 8.5% a year. Now you get interest rates of just 7.5% a year. You got to do something different.

Remember: Turtles only advance when they stick their neck out. If you want to save money for retirement, you must invest in equity (equity mutual funds and stocks).

Sure…investing in equity is risky, but you get higher returns for a higher risk. You can no longer depend on small saving schemes to achieve short term financial goals, like investing money to go on a foreign holiday. You have to shift your focus to equity. One man’s loss is another man’s gain. The mutual fund industry particularly equity mutual funds, would benefit from cut in small saving scheme rates.

And now some politics…..

Government Under Attack

The Government has taken a very bold decision to cut interest rates on small saving schemes. This is a very unpopular move and could anger the politically strong middle class and also senior citizens. The opposition is expected to attack the Government on this move. 

Government Defends its Decision

The Government believes that the economy needs a kick start. This can only happen if banks cut lending rates and offer loans to borrowers at low rates. If banks offer depositors high interest rates on fixed deposits and small saving schemes also offer high rates to investors, who would take risk and invest in equity.To kick start the economy, investors need to invest in risky financial products like equity. Higher return for a higher risk is the need of the hour.

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