Why public provident fund offering 7.1% is still attractive

Despite 80 basis points cut in interest rate on public provident fund (PPF) by the Government of India, PPF still remains an attractive investment avenue in fixed income. 7.1% payable annually on PPF is tax free for the investor is by far the highest an investor can get after Senior Citizen Saving Scheme (SCSS) and Sukanya Samriddhi Yojana (SSY) offering 7.6%. Comparing the revised rate of interest on PPF with the repo rate, yield on 10 year government of India bond, SBI fixed deposit and inflation the PPF rate is still very attractive and there is further scope for reduction.

For time being, the PPF is the best fixed income investment given the sovereign guarantee it comes with and tax exempt nature of interest income it offers. PPF rules pertaining to withdrawal have undergone many changes and made the product more attractive. Though there is a scope for further cut in interest rate on PPF, investors can continue with their PPF investments.

For more elaborate understanding do read further.

Government of India decided to align the interest rates on small saving schemes (SSS) with market forces by reviewing them quarterly from 18 March 2016. This was done in line with the recommendations of Shyamala Gopinath Committee on Small Saving Schemes in 2014. Though the government had in-principle accepted the need to link the interest rates to the market forces, the government has been slow in bringing down the interest rates payable on SSS. The SSS are used by weaker sections of the society such as senior citizens, rural and agriculture workers in the low income segments. The political implications of reducing the interest rates have always been high and no wonder the government always went slow on cutting the interest rates.

However the things changed with the worldwide coronavirus pandemic (COVID19). The global economy is seen slowing down. BofA Securities in its global viewpoint note states it clearly, “global GDP growth to drop effectively to zero this year, matching the major recessions of 1982 and 2009.”

Government need to propel the economic growth engine which is seen decelerating as the entire country goes into three week lockdown. Monetary policy measures – repo rate cut and CRR cut along with other measures totaling around Rs 3.75 lakh crore is expected to offer some support to the Indian economy. The benefit of lower interest rates need to be given to the borrowers. However for that the cost of funds need to go down. The banks are keen to cut the fixed deposit rates. However, the banks need an assurance that they will get the money in their fixed deposits even at lower rates. The SSS offering around 150 basis points (100 basis points = 1 percentage point) more was a clear winning option for most retail individual investors. As the government is now keen to propel the economy the government has acted in favour of banks by cutting the interest rates on SSS. Now the spread stands reduced to around 50 to 60 basis points.

Despite this cut, PPF still is an attractive investment option. The rate on offer is still attractive.

A look at interest rate movements represented by repo rate announced by Reserve Bank of India, PPF, yield on 10 year government bond and five year bank fixed deposit issued by State Bank of India, makes it clear that PPF rates are still higher.

Also these rates studied are before the impact of income tax. All interest income is added to the recipient’s income and taxed as per slab rate. However, in case of PPF the interest income earned is exempt from income tax. That makes PPF an attractive investment option for all investors – irrespective of the tax slab. Investors will be better off continuing with their PPF contributions. Even new account can be opened if one does not have one.

However the situation demands investors to be cautious as well. The interest rates are going down. Investors should avoid chasing returns in fixed income space. Fixed deposits, non-convertible debentures with unknown issuers should be avoided. Co-operative credit societies and co-operative banks fixed deposits can be risky though they may offer high interest rates.