How are interest rates on small savings schemes decided?

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How are interest rates on small savings schemes decided?

Given the importance of small savings schemes as a financial safety net of sorts to small savers as well as a way for the government to finance its fiscal deficit, the manner in which interest rates on these schemes are decided is vital.

Since 2016-17, the government has been announcing these interest rates for every upcoming quarterly period. Until then, a fixed number was announced for the entire year. Further, since 2012-13, these interest rates have been decided on the basis of a formula instead of any arbitrary level, making it a more transparent process.

As per the formula, interest rates on small savings schemes are linked to the market yields on the government’s securities and are 0-100 basis points higher than the yield of the securities of a similar maturity in the reference period. For example, if the market yield on the government’s five-year bond is 8 per cent in the reference period, then the rate of interest on the five-year time deposit should be 8.25 per cent as the ‘spread’ per the formula is 25 basis point for the five-year time deposit.

However, it has been seen on many occasions in the past few years that the small savings interest rates have not moved in tandem with market yields on government securities. In September 2022, the Reserve Bank of India said in its Monetary Policy Report that the interest rates on these schemes were 44-77 basis points below the rates suggested by the formula. At other times, the rates have been higher than what they should be as per the formula.

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