Indian budget: the small savings puzzle

I had ended my last column in MINT on the budget titled, ‘The Colonial Hangover’ with a question on the abrupt reversal of revenue expenditure into capital expenditure in the Ministry of Roads.

(1) A friend sent me the ‘Demands for Grants’ for the Ministry of Roads [Link]. It appears that expenses under ‘Roads and Bridges’ have now been largely moved to Capital Account.

Revenue Expenditure under ‘Roads and Bridges’:

Budgeted: 41617.64 crores of Rupees (416.1764 billion Rupees)

Revised: 6919.27 crores of Rupees (69.1927 billion).

Capital Expenditure under ‘Roads and Bridges’:

Budgeted: 49717.00 crores of Rupees (497.170 billion Rupees)

Revised: 72279.20 crores of Rupees (722.792 billion Rupees)

But, no explanation.

(2) Similarly, some questions were raised on the massive jump in the Government Securities issued to the National Small Savings Fund.

Some numbers:

Securities against Small Savings (Rupees Crores)

Actual 2015-16:      54237.47

Budgeted 2016-17: 25375.25

Revised 2016-17:  95380.57

Budgeted 2017-18: 108661.16

See the big jump from ‘Budgeted’ to ‘Revised’ for 2016-17. The government kept its market borrowing down by borrowing heavily against Small Savings. The data on total small savings mobilisation (net of withdrawals) is available only up to 2014-15 in the National Savings Institute website. It was only around Rupees 40,400 crores in 2014-15 (Rupees 404 billion).

But, in 2016-17, as per this story, the mobilisation was rather brisk, reaching 101,000 crores (Rupees 1010 billion or 1.01 trillion) by November 2016. So, the government could issue securities against it and borrow. How did it do so?

[Some are puzzled by the big jump in savings under the Small Savings Schemes. The official numbers for 2015-16 are not available but they would have been closer to 60,000 crores of Rupees. So, more than 100,000 crores of net inflows in eight months of the financial year does represent a big jump and deserves examination.]

It did not revise down the interest rates on small savings schemes. It kept the small savings interest rates unchanged after announcing with great fanfare that it would be linked to the yield on Government Securities. It announced one set of rates in March 2016 for the April – June 2016 quarter. Apparently, it had announced another for the July – Sept. 2016 quarter but did not change the rates. After that, there has been silence.

Effectively, what the government has done is to borrow from the small savings at higher rates of interest as, otherwise, the schemes could not pay the interest rate promised to the depositors.

From the budget document, ‘Receipts Budget: 2017-18’ (Capital Receipts – CR.PDF):

Presently the term of Central and State Government Securities is 10 years, with no moratorium at 9.5 per cent interest rate.

In effect, this is an interest rate subsidy from the Government of India but it is not counted as such. Put differently, it is an economic growth subsidy. But, the commercial costs are borne by the banks. Let me explain.

If the small savings net inflows were 40,400 crores in 2014-15 and if it had surged to over 100,000 crores in about 8 months of the financial year in 2016-17, theoretically, it is the money that could have gone to banks, had the interest rates been comparable. That is not the case. Therefore, banks are not getting the money in as deposits. Hence, they are not making the loans. Nor are they able to lower the lending rates, if they cannot lower the deposit rates for fear of losing more deposits to Small Savings Schemes.

[It appears almost as though the government, the major owner of the Indian banking system, is, in parallel, running a competitive system in place!]

The Reserve Bank of India pointed this out in its latest monetary policy statement:

Since the introduction of the formula in April 2016, interest rates on small savings are about 65-100 basis points higher, depending on tenor, compared to what they should be if the formula is followed. If the spread between small savings rates and bond yields remains wide, the diversion of deposits to small savings would impede a full transmission to bank lending rates. [Link]

Therefore, is this the most efficient application of subsidy?

I can answer it myself. It is not just banks that have a balance sheet issue. So, do the borrowers. Hence, if interest rates in small savings schemes were not so high, that money would have come to banks (or gone to unsafe Non-banking finance corporations?) and banks, in turn, would have parked it in Government Securities. It may not have helped credit growth by much. Borrowers are reluctant and there is economic uncertainty too. Hence, incremental bank deposits would have gone to the government in the form of lower yields and government’s interest outgo would have been lower. That accrues to the entire government budget and the government will have extra resources to spend on any thing it wished to.

Now, the government is directing its subsidy mainly towards the savers in Small Savings Schemes. The idea of budgeting a lower market borrowing is to keep interest costs down. The purpose is lost if it is replaced by a high cost loan from the National Small Savings Fund.

So, the question remains as to whether this is the most efficient application of a government subsidy. I think the discussion is worth having.


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