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Lower PPF rates can bring down your home loan rates, here’s how

The rate of interest on the PPF scheme has been cut to 8.1% for investments made during April 1-June 30, 2016 from 8.7% currently.

business Updated: Mar 19, 2016 11:15 IST
Gaurav Choudhury
Government’s decision to cut PPF interest rates is expected to bring down home and other loan rates.
Government’s decision to cut PPF interest rates is expected to bring down home and other loan rates.

The government announced on Friday cuts in interest earned on a range of state-run savings schemes including the public provident fund (PPF), the Kisan Vikas Patra (KVP) and senior citizen deposits.

The rate of interest on the PPF scheme has been cut to 8.1% for investments made during April 1-June 30, 2016 from 8.7% currently.

Investments in the Kisan Vikas Patra will earn a return of 7.8% from 8.7% at present, while senior-citizens savings scheme deposits of five years would earn 8.6% interest compared with 9.3% currently.

Read | Public provident fund interest rate cut from 8.7% to 8.1%

The move is expected to bring down your home and other loan rates.

Here’s how:

# When you park money in a fixed deposit (FD), a bank is effectively borrowing from you by offering a fixed rate of return for a fixed period.

Bankers say this limits the banks’ ability to cut lending rates each time the Reserve Bank of India (RBI) cuts the repo rate, as banks cannot “borrow” at high rates through FDs and give out long-term loans at lower rates.

# Banks say they are forced to offer high interest rates to depositors to make it more attractive for people to park extra funds with them ahead of post-office and other state-run savings schemes.

# Banks also point out that they have to offer high FD rates to maintain its attractiveness in wake of competing instruments such as Public Provident Fund and Sukanya Samriddhi Scheme that come bundled with better tax incentives and high returns for customers.

#   Bank FD rates in India currently range between 7-8.5% for different maturity periods. From a “returns” point of view, for a customer, it is more attractive to park funds in post office time deposits than bank FDs.

# One can expect banks to announce a cut in FD rates in the coming weeks, as FD rates are usually lower than post-office time deposit rates.

Lower FD rates, in turn, will bring down banks’ costs and prompt them to cut lending rates for individual and corporate loans.

# Unlike many countries, the Indian system suffers from a peculiarity. While some retail lending rates such as home loans “float”, the main deposit rates are “fixed” both in tenure and interest rates.

#   While the RBI has cut the key policy rate by 1.25 percentage point in the past year, banks have passed on the benefit to borrowers by lowering lending rates by just 0.70 percentage point.

# The government last month announced a decision to move to a new system for interest rates on state-administered schemes, making these market-linked.

#  Market rates move in tandem with government bond rates that are currently on a downward trend.

# The decision to cut interest rates on PPF and other schemes is based on this market-linked system.

Lower earnings on these schemes could now force millions of households to shuffle their savings portfolios. Middle-class Indians rely on small investment options offered at post offices for social security and parking surplus cash.

# Total outstanding deposits in such schemes stand at over Rs 9 lakh crore. Indians have been parking more than Rs 50,000 crore annually as additional savings in these instruments over the last three years. The government depends on this pool of money, also called the National Small Savings Fund (NSSF), to finance part of its budget.