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Centre cuts interest rates on PPF, small savings by 1% - Views on News from Equitymaster
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  • Jan 15, 2000

    Centre cuts interest rates on PPF, small savings by 1%

    The government has cut the interest rates on public provident fund (PPF) and small savings deposits by 100 basis points. The schemes covered under the small savings deposits include the post office schemes, National Savings Certificate and the Kisan Vikas Patra. The PPF rate will stand at 11% after this revision.

    The decision to lower PPF and small savings rate will usher in an environment that is conducive for lowering interest rates both borrowing and lending. Offlate there has been criticism that interest rates have become sticky at higher levels mainly due to the high return offered by the PPF and small savings schemes.

    The move will be appreciated by the large number of borrowers that are either planning to or have finalised plans to enter the debt market. Another key beneficiary of this will be the banking sector that would now be able to raise funds at lower interest rates. And, of course, the biggest beneficiary of the entire exercise will be the Government of India.

    The Indian government currently has an internal debt burden of 36% of GDP (FY00 budget estimate). In view of this, a one percent reduction in interest rates is expected to reduce interest costs by Rs 33 bn per annum. This will help lower the government's interest burden and consequently the fiscal deficit.

    For the corporate, the move is well timed. The Indian industry has been picking up momentum in recent months. The rate cut, which is expected to lead to lower lending rates, will boost industrial investment activity. The companies will also benefit on account of a lower debt service burden that will then directly add to their bottomline. Another benefit would be the pick up in demand for interest rate sensitive goods including durables, cars and homes.

    The banking sector would benefit in terms of lower cost of funds, as deposit rates take a dip. In all likelihood, a part of the gain in spread would be passed on to borrowers in terms of lower lending rates. Another fallout of this decision would be the reduction in the spread between term rates offered by the banks and the returns offered by the government's savings schemes. This would lead to fresh inflows into the banking system, which had until now been losing out to the higher paying government deposit schemes.

    The stock markets will probably react favourably to this announcement. Improvement in corporate bottomline and lower fiscal deficit will boost sentiment. Furthermore, as borrowing costs come down, the expected returns from stock market investments will take a dip leading to higher investment inflows.

    The rate cut is a step in the right direction. Although the investors in such schemes may lose out, they will gain in terms of lower financing costs and a better economic climate that is conducive or growth.



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