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April 05, 2018

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PPF Rate Cuts: Causes and Impact on Economy

GK - PPF Rate Cuts: Causes and Impact on Economy

Published: Tuesday, 29 March, 2016 11:00 AM

PPF Rate Cuts: Causes and Impact on Economy

MBA aspirants must be updated with General Awareness on current affairs. General Awareness topics with analytically drawn conclusions will benefit you in XATIIFTNMATSNAP ,CMATMAT, and later in Post exams screening Tests like  WATGD & PI , Essay writing

Read General Awareness Topic:  PPF Rate Cuts: Causes and Impact on Economy

On March 18, 2016, the Central government reduced the interest rates on small saving schemes like Public Provident Fund (PPF), Kisan VIkas Patra (KVP), and National Saving Schemes (NSS) lending its critics another weapon to launch another spate of attacks on it. Interest rate on PPF was reduced from 8.7% to 8.1%, on NSS from 8.5% to 8.1%, on KVP from 8.7% to 7.8% and on five-year recurring deposit to 7.4% from 8.4%.

The NSS, PPF and KVP are instruments which are considered to be most secured form of investments and therefore very popular among the middle and lower middle class. Consequently, often the elected governments either intermittently increase the interest rates of such schemes or keep them unchanged but very seldom were found reducing the interest rates. Then why the current government will go for an unpopular move when assembly elections in three states and a union territory are round the corner. Perhaps because the long term goals and macro-economic fundamentals demand such anti-popular moves.

Post Office schemes

The National Saving Institute cited downward revision of two year yield on Government securities as the major reason behind the move. Other major reasons which accentuated the need of fall in interest rates and their anticipated impacts are as under –

Economic Growth

Though Indian economy is currently one of the fastest growing economies in the world but the predicted 7.75% GDP growth rate is far below its potential. A low interest rate regime is always considered as growth friendly because in such a regime there is very little incentive to park the funds in saving schemes in while returns from some real investment are comparatively higher.

Increasing Demand

When the interest rates are low, consumer is induced save less and consume more because of which overall demand is increased. The increase in demand induces a price rise which attracts more investment, employment and ultimately a high growth phase and virtuous cycle of prosperity.

Fiscal Situation

Fall in interest in government saving schemes will also improve the fiscal position of the government. Since PPF, NSS and KVPs etc form the part of government borrowing programme, a higher interest on these schemes means more fiscal burden for government. Thus, the reduction in interest rate will help the government to meet its fiscal target. Once the fiscal situation is brought under control, it would also easier for the government to subdue the inflationary pressures.

Health Of Public Sector Banks

The most public sector banks are currently going through a bad patch and are in urgent need of funds to the tune of INR2.4 lakhs crores for recapitalization. The dichotomy of interest rates between government backed schemes and public sector banks is diminishing. When the public will find government schemes less lucrative for investment, they may start depositing money with the public sector banks thus providing them with much needed funds.

Greater Manoeuvrability For RBI

As already stated, a low interest rate regime is considered as growth friendly. The interest rate of PSUs is determined by the Reserve Bank of India (RBI) which reduces or increases the interest rates depending upon the situation whether it requires fuelling of growth or controlling the inflation. RBI is often criticised for ignoring growth and giving preference to control the inflation and therefore it is very conservative in reducing the interest rates. Now as the government had reduced the interest on government saving schemes, RBI will have greater freedom in manipulating the monetary policy.

Apart from the aforesaid reason, low interest rate brings in a good investment climate which is always a welcome step except in the conditions of hyperinflation. When not just in India but across the globe everyone is talking about start up boom, a business friendly environment is the need of hour and India cannot afford to remain laggard for just a few populist reasons. Better macroeconomic fundamentals should always be preferred to the populist microeconomic goals and hence it is a welcome move.

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