The Unsustainability of Govt. Savings Schemes
Jan 17, 2003

Here's a quick question. If you are looking at investing say Rs 100,000 for 5 to 7 years, which is the first instrument that comes to your mind?

There is a fair chance that the instrument will be one of the following:-

National Savings Certificate
Kisan Vikas Patra
Public Provident Fund
RBI Relief Bond

All savings schemes offered by the Government of India! To learn more about how government saving schemes will be impacted in in 2003, download our FREE Guide.

Then of course there is the very popular Monthly Income Scheme (MIS) offered by the Post Office. Here again the tenure is 6 years, and the interest rate offered is 9% p.a. (Sec 80 L benefits are applicable on the interest earned).

Now, what makes us question the sustainability of these savings schemes?

One basic rule in finance is that the longer the tenure of the instrument, the more the uncertainty associated with it (i.e. higher the risk) and therefore higher the interest rate. Of course, another factor that would affect the rates will be the credibility of the borrower.

The listing below brings to the fore a significant distortion in the interest rate structure. Although this may not be very apparent, the graveness of the situation becomes very clear when one realises that the 10-yr government paper (which is as safe as any of the instruments listed above) offers a yield of only 6.0% even as the 5 year Relief Bond yields 8%!

The chart below depicts this rather well.

	Tenure (Yrs)	Interest Rate
RBI Relief Bond	5	8.0%
RBI Savings Bond	6	7.0%
NSC	6	9.0%
G-Sec	10	6.0%
PPF	15	9.0%

Annual Payment option

From the chart it is apparent that there is no clear trend in interest rates across instruments (with similar credit quality) of varying maturity.

Now the question is why should the government borrow via these savings schemes when it can raise money from the market at a much lower rate? It is in a way a subsidy offered by the Government of India.

The sustainability of these schemes is more in doubt today than it ever was. The reason for the same is very clear the actual return on instruments in which these schemes invest is much lower (and falling) than what is being announced as a return. The inherent deficit (excess of interest paid over income earned), which continues to grow, needs to be made up by the government (something like what the government had to do for the UTI only that sums involved in government savings schemes are much larger). Given the government's compulsions to clean its books of such liabilities, it is unlikely that such distortions will persist.

To put this in perspective, let's take an example.

Suppose, the government has mobilized Rs 100 in the PPF, on which it has guaranteed to pay 9% p.a. compounded for 15 years. The value of this Rs 100 will grow Rs 364 approximately at maturity. Now given that interest rates have declined significantly and the 10-year government paper is yielding only about 6%, it is more reasonable to assume that the PPF will earn only about 7% p.a. compounded. Using this return, the actual value of the assets would have grown to Rs 276 approximately.

Therefore, on maturity the government will have to make good the deficit of Rs 88. Now, that is Rs 88 of future deficit for every Rs 100 invested in the PPF account today! The amount of money invested in the PPF probably exceeds Rs 500 bn (budget documents too do not provide a separate figure for the amount of money in PPF).

Do you think the government has the capacity to foot this bill? And, remember that huge deficits are simultaneously building up in other guaranteed return government schemes.

So before you decide to put all your eggs in the governmen's basket, think. Make sure you are well diversified in your investments.

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