Till last week, you could have invested in small savings schemes floated by the government with your eyes shut. This is no longer true. With the interest rates on these schemes now linked to the government bond yields, an investor will need to assess the future movement of interest rates before committing money to these options. It is a paradigm shift that transforms these fixed income options into market-linked products. "My investments will be no different from a home loan, with the interest rate changing every year," says Raj Kumar Dogra, a Mumbai-based lawyer, who has invested Rs 15 lakh in the Senior Citizens Savings Scheme (SCSS).
Till now, his investment has earned a fixed return of 9% per annum. This year, it will earn an interest of 100 basis points (100 basis points = 1%) higher than the yield of 5-year government bonds. Although the current yield is close to 8.85%, the scheme will offer 9% because the rate is to be fixed at the beginning of the financial year. In April 2011, the 5-year government bond yield was 8%. Likewise, PPF investors will earn 8.6% on their corpus this year, while NSCs will fetch an interest of 8.4%. Powered by the magic of compounding, this higher rate can translate into big gains over the long term.
The revision in interest rates is a bonanza for investors. The shift to market-linked returns coincides with government bond yields hitting three-year high levels. If the government bond yields continue to remain at the current high levels till the cut-off date in April 2012, investors in long-term options, such as the PPF, NSC and the SCSS, can expect a return of more than 9% in the next financial year. "The G-sec rate would move only marginally in the coming months as we don't expect the RBI to cut rates and the fiscal worries are unlikely to be sorted out," says Indranil Sengupta, an economist with Kotak Bank.
However, market-linked return is a double-edged sword and the rate could also fall to below 8%. In the past 12 years, the 10-year yield has fluctuated between over 10% and below 6% (see chart). Investors like Dogra are not sure how the transition to market-linked returns will impact them. "A fixed return is important for senior citizens who depend solely on the income from investments. I am content with a lower return but it must remain fixed," he says. However, as Charul Shah, a Mumbai-based financial planner, says, "Debt investments are an integral part of one's portfolio. They should be actively managed too."
The government has been spurred into hiking the rates due to an alarming fall in collections by the small savings schemes. Though these options have been the favourites of small investors for a long time, the high deposit rates offered by banks have led to a dip in small savings collections in the past 2-3 years. These funds are used to partially finance the deficit. The revamp is part of the government's strategy to put its borrowing programme back on track.
This all-time favourite option becomes even more attractive after the revamp. It has been benchmarked to the 10-year government bond yield. Your balance will earn 25 basis points higher returns than the benchmark. The biggest gainers will be investors who have already accumulated a large corpus of Rs 15-18 lakh over the past 10-12 years and could expect higher returns in the next 1-2 years before the interest rate cycle turns.
Another important change has been the raising of the PPF investment limit from Rs 70,000 a year to Rs 1 lakh. This make the PPF a good tool for retirement planning. Till now, assuming a return of 8%, a PPF investor could accumulate a maximum of Rs 20.52 lakh in his account over 15 years. Now, with an additional Rs 30,000 flowing into the account, he will be able to accumulate Rs 29.32 lakh. Plus, the Rs 2,400 interest earned on the additional investment of Rs 30,000 will escape the tax net every year. The corpus will be bigger if we assume that the new rate of 8.6% will continue for the next 15 years. If a couple starts contributing Rs 1 lakh each to the PPF every year, they can build a tax-free corpus of Rs 61.8 lakh over 15 years. "The PPF scores over all other small savings schemes because the corpus is totally tax-free," says Lovaii Navlakhi, financial planner with the International Money Matters.
The investment is also eligible for tax deduction under Section 80C of the Income Tax Act as well as under the Direct Taxes Code. If we take into account the tax saved, the return is as high as 12.65% for taxpayers with an annual income of over Rs 8 lakh. The only negative is that loans from the PPF will now come at 2% instead of the earlier 1%.
Source : The Economic Times
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