The evolution of Public Provident Fund (PPF) Interest Rates

A provided fund for the general public came into being by an act of parliament in "in the nineteenth Year of the Republic of India" (1968) and has since evolved with the Indian economy. In this post, let us consider the way in which the interest rates of the public provident fund (PPF) has changed since inception. The PPF ACT 1968

The idea is to understand the factors (at least a couple of them) that affect the interest rate so that we can react to future rate changes with better perspective.

The way PPF interest was/is determined

It is such a pity that I am not able to find an authoritative source on how the PPF interest rate was set before 1998!

Since 1991 the government had constituted committees from time to review small savings schemes and recommend interest benchmarks.

The first such committee in 1991 chaired by Dr Rangarajan only said

The existing pattern of administering Small Saving Schemes may continue.

The second committee chaired by R V Gupta (1998) noted

The rate of interest on PPF would be set at par with the rate of interest on GPF.

Reddy Committee (2001) 

Yearly average secondary market yield on G-secs of comparable maturity as the appropriate benchmark with a positive spread of up to 50 bps depending on the maturity and liquidity of the instrument. Periodicity of revision to be on annual basis.

The Rakesh Mohan Committee (2004) suggest a more elaborate formula based on the above lines.

The money collected under small savings schemes goes to the  National  Smal Savings Fund. From here, the Central government lends money to the states for different durations. The interest of these loans was anywhere between 2-3% higher than the interest of the small savings schemes (of which PPF is one)!!

Thus, the cost of borrowing from the centre is much higher than the cost of borrowing directly from citizens. The Rakesh Mohan committee noted that unless this spread of 2-3% is not lowered by benchmarking the small saving schemes to government bonds, the states cannot handle the fiscal strain.

Broadly speaking this is the reason why interest rates are now fixed each quarter. The 0.5% extra interest wrt the GOI bonds has come down to 0-0.5% depending on the scheme.

The quarterly reset was recommended by the Shyamala Gopinath committee in 2011, who also agree with the previous two committees,

secondary market yields on Central government securities of comparable maturities should be the benchmarks for the various small savings instruments

PPF Interest History

Even though the exact interest calculation method before 1998 is not known and only 2001 benchmarking with G-secs began, it is not a bad approximation to assume the PPF rate evolves the same way as the 10-Y G-sec yield.

There are main factors that drive bond yields - inflation and credit worthiness.  In the  case of PPF, economic drivers like fiscal deficit, corporate earnings should also determine the attractiveness of small savings schemes. I wish I can write with more authority on this, but I am only a student of this exceedingly interesting subject: The history of the Indian Financial System. (page 331)



Notice that the PPF rate has steadily increased since inception up to 1990, remained flat at an astonishing 12%, fell down sharply to a plateau at 8% and then reacted to inflation.

The sharp increase in from 5.8% to 7% in 1974 was most likely triggered  by the four-fold increase oil prices due to an embargo triggered by Americal aid to Israel. Read more:  1973 oil crisis

After the inception, we have had the Bangladeshi liberation war (1971), the emergency (75-77) and Indias worst economic crisis ever - balance of payments crisis (Mid 80s- early 90s):  1991 Indian economic crisis

India was importing more than it was exporting. It had no forex reserves and it was on the verge of defaulting on payments.  The IMF lent Indian 2 Billion USD with its gold reserve as collateral. The economy was opened up and the great Indian story was all set to begin ... with a big hiccup.

As a result of the economic crisis, Indians credit worthiness failed. It is due to this, coupled by the need for increasing borrowing, the PPF rate shot up to 12%.

Why it remained there at 12% for a decade is a mystery to me. The initial half of the 90s was spent in consolidation of forex reserves. Meanwhile, another story was unfolding - The Harshad Mehta scandal. A decade after this, the Sensex was flat - our very own lost decade (like Japan). Although inflation was not alarming, perhaps because of lack of productivity, the interest rates were quite high in the late 90s too. I am still searching for confirmation on this.

In the early 2000s the situation improved. Inflation fell sharply ~ 5-6%. The govt dramatically dropped interest rates and the great Indian bull run began. Debt funds gave 15-17% returns because of the rate cut!!

Inflation increased gradually and probably healthily as the market reached all-time highs (then).  Soon came the 2008 crisis, recession, inflation and the now the rates have started to fall again.

Could this be the start of another bull run? Let us hope so.  When the PPF rate was decreased by 0.6% there was an 'outcry'. Let us look back at history and recognise that we are a slave to the economic machinery. Much larger changes have taken place before ... when there was no social media!

A high PPF rate does not always mean things are rosy!

Reference: EPF Interest Rate History The EPF (and GPF) rates have followed PPF rates closely. Typically the EPF rate has been about 0.5% on average higher than the PPF.

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