An unkind cut for senior citizens

Alok Ray

The Government recently announced a significant reduction in interest rates on the so-called ‘small savings’ instruments — including various postal savings schemes, Senior Citizen Savings Scheme (SCSS) and Public Provident Fund (PPF) — to bring them in line with comparable bank fixed deposit interest rates. With rates likely to go down further, senior citizens, who depend on interest income for survival, are naturally upset.

The Government has stuck to its fiscal consolidation targets which the RBI considers a precondition (along with falling CPI inflation) for further cuts in the ‘repo rate’ (the rate at which RBI lends short-term funds to banks). 

Combined with the RBI dictum to banks to use ‘marginal cost’ (instead of average cost) of funds to determine the ‘base rate’ for lending, this should reduce interest rates for all depositors and borrowers across the spectrum. It implies that senior citizens would suffer more in the coming days.

Basic logic

What is the basic argument for bringing down interest rates for small savings instruments in line with bank interest rates? One major reason why banks fail to pass on the rate cuts to customers is that the effective interest rates on postal savings instruments, Senior Citizen Saving Scheme (SCSS) and PPF (specially if the tax benefits from PPF savings are taken into account) are significantly higher than those offered by bank FDs. As a result, even if the RBI reduces the repo rate, banks cannot afford to reduce the interest rates on FDs which, in turn, restricts their ability to lower interest rates to borrowers. So, in the interest of more efficient transmission of monetary policy, the RBI has announced substantial cuts in interest rates on postal savings schemes, SCSS and PPF.

Most economists would agree with the arguments advanced up to his point. The trouble arises because, in India (as in most developing countries), the interest rate instrument is used to promote more than one policy objective. 

In the absence of a workable social safety net, the interest earnings from accumulated savings serve as the only available means to protect the real income of senior citizens other than those receiving inflation-indexed monthly pensions. The across-the-board reduction in interest rates, even when justified in the interest of more efficient monetary policy transmission, may go against the objective of income stabilisation for the retirees.

Some economists argue that real interest rates (equal to nominal interest rates minus inflation) would remain the same when, along with reduction in inflation, the nominal interest rates are also being cut equally. Hence, there would be no adverse impact on interest earners. This argument is invalid since consumer prices are rising even when consumer price inflation is falling, unless, of course, we are considering a negative inflation rate (which is not the case in India). 

So, the nominal income from interest earnings would be falling while the nominal cost of living as reflected in expenditure on food, house rents, electricity bills and medical costs are rising or at best remaining the same. Clearly, the standard of living of the people depending on interest earnings for survival would be squeezed.

The question is, how to cushion the impact on less affluent retirees living on interest income, with least damage to monetary policy transmission. Several options can be considered. One, the interest rate on the SCSS may be left unchanged. Since one can invest only up to a maximum of ₹15 lakh in this scheme and even a 10 per cent interest would fetch only ₹1.5 lakh interest income a year, the major beneficiaries would be senior citizens with income well below the tax- exemption limit of ₹3 lakh a year. 

Given that only bonafide senior citizens can avail themselves of SCSS and that, too, up to a maximum total investment of ₹15 lakh, the additional interest cost on banks would be limited.

Finding solutions

There is much less justification for not reducing the interest rate on PPF which offers triple tax benefits (‘EEE’ meaning tax exemption on investment amount, interest earnings and withdrawal). Only relatively affluent people (not limited to senior citizens) with surplus income to save can make use of this scheme to save taxes. 

Each year, a person can invest up to ₹1.5 lakh in PPF, saving taxes of more than ₹45,000 (if in the 30 per cent tax plus surcharge bracket). Further, given that the interest income from PPF is totally tax exempt, the effective return from this instrument is much higher than all other schemes, including SCSS. Since all (affluent) people, irrespective of age, can invest in PPF, the additional interest cost and tax revenue loss could be a lot more than in the case of SCSS.

Raising the extra interest rate for senior citizens from the current 0.5 per cent to, say, 1 per cent, while reducing the general FD rates, is another possibility. 

Since the FD interest income is taxable, the biggest benefits would again accrue to poorer senior citizens below the tax exemption limit and progressively less for people in higher tax brackets. As postal deposit rates are being brought in line with bank FD rates of comparable maturity, the same extra interest benefit should be offered to senior citizens by post offices also (which is not the case now). 

All these modifications should be supportable on both equity and progressivity principles of public finance.

Apart from the economic justification advanced above, in a democracy, the electoral power of senior citizens (whose number is increasing with rising longevity) cannot be ignored. The recent roll-back of the Budget proposal for (partial) taxation of withdrawal from EPF, due to public outcry, is a case in point.

The writer was a professor of economics at IIM-Calcutta