Worried about 7.1% PPF interest rate? It is higher than what it should be!

The big drop in PPF and SSY interest rates (among others) is a hard pill to swallow but here is why they are higher than they should be!

Published on / By M. Pattabiraman Twitter: @pattufreefincal / 3 Comments

Published: March 31, 2020 at 10:40 pm

Last Updated on March 31, 2020 at 10:40 pm

The finance ministry has reduced PPF rates from 7.9% to 7.1% for the second quarter of 2020. Sukanya Samriddhi Account Scheme rate has also gone down from 8.4% to 7.6%. If you are worried about this then you have missed all the signs of the inevitable and correct direction in which the country is moving. These rates are higher than what they should be!

Some history: Several committees that have discussed the future course of small saving schemes have recommended to the government for years now that it can longer set flat interest rates for these schemes and that these instruments must be linked to market rates at least once every quarter. Read more: The evolution of Public Provident Fund (PPF) Interest Rates.

In Feb 2016, the Govt agreed and decided to recalibrate the interest rates of all small savings schemes “on a Quarterly Basis to align the small saving interest rates with the market rates of the relevant Government securities”

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The 10-year government bond is usually considered as the benchmark for PPF and the newly introduced Sukanya Samriddhi Yojana (SSY).  Sukanya Samriddhi Yojana (SSY) is supposed to have a rate of 0.75% more than over “prevailing 10Y bond market rates” and PPF a 0.25% higher return.

The last three-month 10Y bond yields are (source in.investing.com)

  • Feb-2020: 6.37
  • Jan-2020: 6.60
  • Dec-19: 6.65
  • Average: 6.51

So for SSY 0.75% + 6.51%, the rate should be 7.25% and for PPF, 0.25% + 6.51%, the rate should be 6.75%. The declared rates for Q2 2020 are 7.6% for SSY a good 0.35% more and for PPF it is 7.1% also 0.35%. In Sep 2016 we had pointed out that PPF and SSY rates were 0.5% higher!

Therefore it is a good sign that the gap is reducing but still considerably high. Naturally, investors with a debt-heavy portfolio, especially senior citizens will feel the pinch. This reduction of rates has been a gradual process and there was plenty of warning.

What should senior citizens do now?  1: do not switch to debt funds! Market risk and credit risk will be harder to bear. 2: Do not switch to small finance and co-operative banks FDs. If the bank gets into trouble you would wish your money was invested in an equity fund in the middle of a crash! 3: Do not listen to your overenthusiastic children and allow them to play with your hard-earned money. 4: Reduce your lifestyle accordingly. There is no other way out.

For those who are young and years away from retirement, there cannot be a bigger warning to take on market risk while you still can.