The Y. V. Reddy Committee's balancing act

By C. R. L. Narasimhan

The Y. V. Reddy Committee, whose constitution was mooted by the Union Finance Minister in his budget speech has had to grapple with issues which normally defy an easy solution. Asked to review the system of administered interest rates in the country, the committee has taken note of a basic dilemma confronting the policy: small savings instruments originally intended to provide a safe haven for the small investors have become enormously popular over the years and have come to occupy a pivotal place in the aggregate financial savings and - very significantly - of the household sector.

The implicit government guarantees have made them absolutely safe - a major attribute these days. But the higher yield which they generate, made even more attractive by the tax concessions to the investors - under Sections 80L, 88 and 10 of the Income-tax Act that have made the situation wholly untenable.

The dilemma arises because the resources so garnered are used by the Centre and the States to finance their revenue deficits. Eighty per cent of the net collections are lent to the individual States (where the collections are made) as non-Plan loans. Thus mobilisation under small savings are high cost government borrowings.

At present, almost 20 per cent of the combined gross fiscal deficit of the Centre and the States is met through small savings. Hence the more attractive the savings instruments are, the more burdensome they become for the government. The point comes into sharp focus when it is noted that the savings schemes are operated as ``ponzi" schemes, with fresh accretions used to repay the maturing deposits as well as the interest.

The Reddy panel has pointed out that inasmuch as these government borrowings do not create identifiable assets, the sustainability of the savings schemes is in doubt. Maximisation of receipts through small savings runs counter to the minimisation of the debt burden to the Centre and the States. That dilemma becomes even more complex because of the involvement of several stakeholders - investors, Central and State governments, agents, and intermediaries.

What is the solution? The Reddy panel's singular contribution lies in its taking note of the genuine concerns of all those connected with small savings. Of all the stakeholders, the saving class has often felt left out in any debate on savings instruments. The committee feels that an appropriate interest rate regime is necessary to promote savings especially those of households. Therefore, financial savings in general and contractual savings in particular should be encouraged keeping in view the long-term investment requirements of the economy. However, small savings instruments should target only individual small savers/investors.

A role for the private sector

The present system under which the government manages these schemes is expected to be replaced by a new regime where the private sector will play an important role. On the continuance of the administered rates itself (the main reference point), its recommendations are highly practical:

(a) Administered rates can continue only over the short-term;

(b) Even here they will be benchmarked with market determined rates. (The committee has suggested the benchmarks - the yields from different types of government paper as also the spread over and above those which the different savings instruments can offer);

(c) On rationalising the tax benefits the committee has drawn a distinction between instruments of less than six years tenure (short and medium term instruments) and those of longer duration. All existing tax incentives - under Sections 80L, 88 and 10 of the IT Act will have to go for the first category.

The committee has also recommended that with a view to checking tax evasion, there should be a new provision for taxing the maturity proceeds of the short and medium instruments at a flat rate (at present 10 per cent) and a tax deduction certificate will be issued. For long term instruments, tax concession under Sec. 88 - a rebate of 20 per cent on investment up to Rs. 60,000 will continue.

The expectation is that genuine savers will not suffer consequent on the withdrawal of tax incentives. Since the safety factor is inbuilt, there is no need for extra incentives, goes the argument. The interest rates in India according to the orthodox view are in a secular decline. Small savings instruments will offer reasonable return and more importantly their yield will be in alignment with other market based instruments.

In the years to come, the Reddy panel expects funds management to be on a much larger scale than now, be professionally managed and be able to meet a variety of special requirements of the investors. There is therefore no need for any special treatment in taxing the income from the short-dated savings instrument. Valid as these arguments are they do not address the special problems of the savings community at this juncture. But that is a separate issue and beyond the brief of the Reddy panel.

The public finance angle, however, is important. Besides, tax incentives distort the interest rate structure and cause a loss to the exchequer. The committee could not obviously ignore public finance concerns while discussing administered rates and small savings. Simplistically put, there is an expectation that resources from small savings will not occupy such a prominent place in financing the fiscal deficit in the years to come. That again is because these instruments will no longer be as popular as they have been. There would be other avenues competing with the small savings instruments. The latter would have also lost some gloss what with the contemplated withdrawal of preferential tax treatment to their investors.

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Section  : Business
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