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  • : Fixed Income: Playing safe!

    Fixed Income: Playing safe!

    Over the last few years, an overbearing concern for investors in the fixed income (and small savings) segment was rationalisation of interest rates. Attractive returns offered by small savings schemes (like National Savings Certificate - NSC and Public Provident Fund - PPF) coupled with tax sops, in the midst of a soft interest regime, was a dichotomous situation. The general consensus was that interest rates on the small savings schemes would be trimmed down and brought in line with prevalent market rates. However, the authorities chose to leave the rates unchanged. Instead a rather novel approach to rationalisation was adopted.

    For example, some schemes (like Deposit Scheme for Retired Government Employees) were discontinued; similarly, small savings schemes were put outside the investment purview of entities like trusts and Hindu Undivided Family (HUF). In other cases the benefits were trimmed, for example the 10% maturity bonus on Post Office Monthly Income Scheme (POMIS) was scrapped. Interestingly, most of these changes were implemented outside of the Union Budget.

    At present, we are faced with a situation wherein the interest rate cycle has turned around and interest rates are moving northwards. The Reserve Bank of India's (RBI) recent move to hike the Cash Reserve Ratio (CRR) bears testimony to the same. Clearly, any reduction in interest rates on small savings schemes seems unlikely at this stage.

    From an investor's perspective, the portfolio of fixed income instruments that offer tax sops (under Section 80C) is a comprehensive one. NSC and tax-saving bank fixed deposits can find place in the investor's portfolio who wishes to invest for relatively shorter time frames. Conversely, those planning to provide for long-term needs like retirement and child's education can employ PPF. Similarly, other schemes (sans tax benefits) which provide for specific needs like providing regular income i.e. POMIS and Senior Citizens Savings Scheme are also in existence.

    What is likely to happen
    As mentioned earlier, we don't expect any trimming down in rates on small savings schemes. However an unpleasant surprise could be in the form of introduction of the EET (exempt-exempt-taxed) method of taxation while dealing with small savings schemes.

    The Finance Minister first broached the topic while presenting the Union Budget 2005-06. Now could be the time to implement the same. Under the EET method of taxation, while the contributions to and accumulations/earnings from the scheme would continue to be exempt from tax, the withdrawals/maturity benefits would be taxed. The same would result in the scheme losing some of its sheen on account of the diluted tax sops.

    Barring the above, we expect the Union Budget to maintain a status quo in the fixed income (and small savings) segment.

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