PPF Rate Cuts: Causes and Impact on Economy

On March 18, 2016, the Central government slashed interest rates on minor savings plans such as the Public Provident Fund (PPF), Kisan Vikas Patra (KVP), and National Saving Schemes (NSS), giving its detractors another weapon with which to launch another round of attacks. The PPF interest rate decreased from 8.7 to 8.1 per cent, the NSS interest rate from 8.5 to 8.1 percent, the KVP the interest rates from 8.7 to 7.8 per cent, and the five-year recurring deposit interest rate reduced from 8.4 to 7.4 per cent.

The NSS, PPF, and KVP are the safest forms of investing and are thus quite popular among the middle and lower-middle classes. As a result, elected governments frequently either increase or maintain the interest rates on such schemes, but they are rarely found lowering the interest rates. Why, then, will the current government take such an unpopular step when assembly elections in three states and a union territory are just around the corner? Perhaps because long-term objectives and macroeconomic fundamentals need such undesirable choices.

What is PPF?

The PPF stands for Public Provident Fund, which was established in India in 1968 to mobilise small resources in investment and provide a return on them. It is also known as a savings-cumulative-tax savings investment vehicle since it allows one to create a retirement corpus while saving on annual taxes. Anyone looking for a secure investment solution that will enable them to save taxes while earning assured profits should create a PPF account.

Advantages of PPF

• Long Term Capital Appreciation: A PPF converts minor contributions from investors into long-term capital appreciation with some interest.

• Low Risk & Consistent Returns: PPF investment accounts are ideal for risk-averse investors. Investors seek steady returns as well as the protection of their principal.

• Loans Secured by a PPF: Another advantage of a PPF investment is that it can be used to meet both long-term and short-term objectives. It is also helpful in financial difficulty because you can request a loan against your PPF.

• Partial Withdrawal: If you have financial difficulties, you can withdraw money from your PPF, excluding loans. From the fifth-year forward, you can make one partial withdrawal.

• Premature Closing: Although PPFs are intended to be long-term investments, there is a provision for premature closure. Its purpose is to assist investors and to put their money to good use when it is desperately needed. However, only after five years can all invested funds be withdrawn prematurely.

Causes of PPF cut-rate:

• Economic growth 

Even though the Indian economy is currently one of the fastest expanding in the world, the 7.75% GDP growth rate forecasted is far below its potential. A low-interest-rate environment is always thought to be pro-growth since there is no incentive to park money in savings accounts when the rewards on real investments are higher.

• Increasing demand 

As inflation decreases, consumers are compelled to save less and consume more, resulting in a rise in overall demand. Demand increases, causing prices to rise, attracting additional investment, employment, and, eventually, a high-growth phase and virtuous circle of prosperity.

• Fiscal situation

The majority of public sector banks are currently in trouble and require funds to the tune of INR2.4 lakh crores for recapitalisation. The interest rate disparity between government-sponsored programmes and public-sector banks is narrowing. When the public no longer sees government programmes as lucrative investment opportunities, they may begin depositing money with public sector banks, generating much-needed funds.

• The health of Public Sector banks 

A low-interest-rate environment is considered growth-friendly, as previously indicated. The Reserve Bank of India (RBI) sets the interest rate for PSUs, which lowers or raises it based on the situation, such as whether it is necessary to boost growth or keep inflation under control.

Impact on the Indian Economy

According to analysts, the government’s significant reduction in the modest savings rate is a clear signal to the Reserve Bank of India to lower rates.

When small savings schemes offered more excellent rates, banks stated they could not decrease their retail deposit and lending rates. This hampered the banks’ ability to pass on the RBI’s rate decreases to encourage economic development. Despite the RBI cutting rates by 125 basis points last year, banks only decreased lending rates by 60-70 basis points.

In response to the minor savings rate drop, Finance Minister Arun Jaitley stated that the government must strive toward lower interest rates to make the economy more effective. “To make the economy more effective, the government must move toward lower interest rates in lending and deposit rates,” he stated.

“It’s sad for the middle class since deposits will reward them less when the service tax increases. However, reduced rates will help the economy as a whole. The Reserve Bank of India (RBI) will be obliged to contemplate a rate drop, “Equinomics Research & Advisory founder, G Chokkalingam, said. The RBI will carefully watch the monsoon forecast before announcing a significant decrease in its repo rate. The weather service will issue its monsoon forecast in the last week of April.

Despite reducing small savings rates, Dr Ajit Ranade, Senior President and Chief Economist at Aditya Birla Group, noted that investors are earning “acceptable” inflation-adjusted returns on their investments. “When inflation reached 10-11 per cent, and the postal deposit rate was 9.50 per cent, the depositor had a negative return,” he explained.

Conclusion 

We can conclude that interest rate changes can have a beneficial or negative impact on the markets. Central banks frequently adjust the target borrowing costs in response to economic activity, boosting them when the economy is too robust and decreasing them when it is too slow.

When the central bank changes interest rates, it has repercussions throughout the economy.

Lowering interest rates lowers the cost of borrowing money. This boosts asset prices by encouraging business and consumer spending and investment.

On the other hand, lowering rates might lead to issues like inflation and liquidity traps, reducing the effectiveness of low rates.