Revamp ponzi schemes

IT WILL not be in public interest to allow the continuance of ponzi schemes (small-savings schemes) on a longer-term basis.

Hence the Expert Committee to Review the System of Administered Interest Rates felt that, at some point of time, the ponzi nature of the scheme should definitely change. The Committee, therefore, suggests that States should be encouraged to adopt a back-to-back arrangement at the earliest so that the overhang problem would not arise for the fresh flows. In the opinion of the Committee, the time-frame for the same may be spread over six years from 2002.

In general, the tax incentives tend to divert the flow of financial savings to tax-preferred financial instruments. However, there is no strong evidence to support that tax incentives facilitate increased savings at the macro level.

Currently, the structure of interest rates in India has become reasonably flexible, as most of the interest rates relating to banks and financial institutions and the debt market have been deregulated.

The Committee observed that the present system of direct management of long-term funds by the public sector, and fixing administered rates of interest with all tax advantages, would not be sustainable in the medium term.

The feasibility of immediately converting the long-term saving schemes into fully funded schemes seems difficult, given the dependence of the government on such schemes to meet deficits.

In the interim, the schemes could be rationalised, and the rates on small saving schemes be made increasingly market- oriented so that the adverse implications of financial market segmentation are minimised.

The continuation of administered regime of interest rates on small-saving schemes in the above context should, therefore, remain temporary and any benchmarking of these rates should also be treated as an interim measure.

Instruments with same or similar maturity having different tax concessions result in offering different effective rates. Moreover, certain schemes are more liquid than others, posing distortions in alignment with the market rates. As such, the term structure of small-saving instruments gets vitiated. All these issues make benchmarking more complex.

As interest is a future income, it is desirable that small savers get a positive real rate of return on their savings at a future date. As such, while benchmarking small saving instruments, it is desirable that they are linked to the rate of return on capital or long-term growth rate of the economy.

A stable benchmark rate is that which fluctuates within a narrow range and has a low coefficient of variation.

The rates that satisfy stability conditions are considered for benchmarking small-savings rates. These are: a) rate of inflation, b) deposit rate of commercial banks, c) Bank Rate, and d) yield on Government securities.

(Edited extracts from the Report of the Expert Committee to Review the System of Administered Interest Rates.)