India rebounded strongly from its 1991 balance-of-payments crisis, aided by structural reforms and other policy adjustments. The government has sought to reinvigorate the process of structural and fiscal reform. The paper examines trends in interstate differences in rural poverty; reviews India's postal saving system and possible reform issues; describes and evaluates the current system of pensions and provident funds, and discusses reform options. The paper also briefly reviews the structure of and recent developments in the Indian foreign exchange market.


India rebounded strongly from its 1991 balance-of-payments crisis, aided by structural reforms and other policy adjustments. The government has sought to reinvigorate the process of structural and fiscal reform. The paper examines trends in interstate differences in rural poverty; reviews India's postal saving system and possible reform issues; describes and evaluates the current system of pensions and provident funds, and discusses reform options. The paper also briefly reviews the structure of and recent developments in the Indian foreign exchange market.

VIII. Postal Savings in India1

A. Introduction

1. The postal savings system in India consists of various small savings schemes of the Central Government administered through the Post Office Savings Bank under the Government Savings Bank Act (1873) and the Government Savings Certificates Act (1959).2 The Post Office Savings Bank has 154,000 branches that are widely dispersed across India, and its outstanding deposits amount to 9½ percent of GDP.

2. The principal focus of the postal savings system is to attract small-lot savings from small- and marginal-income earners, including farmers, the self-employed, and housewives. The stated objective is to encourage thrift and to provide savings vehicles for retirement and old age, particularly for those segments of the population in remote and rural areas with limited access to the banking system. The Post Office Savings Bank has used its extensive geographical reach—90 percent of its branches are in rural areas—to meet these objectives, evolving in the process into a significant financial institution.

3. To attract deposits, the postal savings system offers competitive interest rates, along with significant tax incentives (Box VIII.1). In the second half of the 1980s, the central government sought to broaden the postal savings deposit base with the introduction of new schemes—the Indira Vikas Patra (IVP) in 1986 and Kisan Vikas Patra (KVP) in 1988—targeted at higher income savers. These schemes tended to have either no upper limit or a very high upper limit on the deposit amount and thus appealed to all types of depositors. The postal savings system has also increasingly focused on attracting deposits in semi-urban and urban areas.

4. Attractive rates of returns on postal savings schemes, along with easy accessibility, have helped the system mobilize large inflows. Deposits rose from 2.8 percent of GDP in 1970/71 to 9.4 percent of GDP in 1999/2000; deposit growth was particularly rapid during the 1970s and 1980s, but slowed in the 1990s (Chart VIII.1). By contrast, bank deposits have steadily increased as a share of GDP during the past three decades, so that postal deposits have declined relative to bank deposits during the past ten years (Chart VIII.2).

Chart VIII.1.

India: Postal Savings Deposits vs. Bank Deposits

(In percent of GDP)

Chart VIII.2.

India: Postal Savings Deposits as Percent of Bank Deposits

(In percent)

Sources: Reserve Bank of India, Handbook of Statistics on Indian Economy; Union Budget documents; Central Statistical Organization.

India: Interest Rates on Postal Savings Schemes1

Interest rates on postal savings schemes are set by the Ministry of Finance and published in the Government Gazette. The Department of Posts, which administers the system through the Post Office Savings Bank, communicates these rates to all its branches across the country. The process of communicating interest rate changes is time-consuming, especially for schemes where fresh savings certificates need to be printed and distributed, and this can cause deposit-taking to come to a halt. This has tended to discourage frequent changes to interest rates.

Historically, there have been no formal guidelines for setting postal savings rates, although, in order to make these schemes attractive, rates have typically been kept above commercial bank deposit rates of similar maturity. Traditionally, this was not thought to disadvantage banks excessively since postal savings schemes were largely concentrated in rural areas and did not compete with bank deposits. However, direct competition with the banks has become more intense in the period since the schemes began to target higher-income and urban savers. State governments have been strong proponents of maintaining high postal saving rates, reflecting their concern that cuts would reduce their access to these funds.

As the Chart shows, postal savings rates have tended to be more rigid than rates on bank deposits. During the period up until 1994 bank deposit rates were set administratively by the RBI and were reviewed twice a year. Since then, bank deposit rates have been gradually deregulated and have become more market determined.


Comparison of Interest Rates

Citation: IMF Staff Country Reports 2001, 181; 10.5089/9781451818550.002.A008

The substantial narrowing of postal savings and bank deposit rates that occurred in the early 1990s began to adversely affect the mobilization of postal savings deposits. At the request of the state governments, the central government appointed the Rangarajan Committee (1991) to examine the relationship between postal savings and commercial bank deposit rates, resulting in large hikes in postal savings rates. The Gupta Committee (1998) looked into issues relating to the determination of postal savings rates in a more deregulated banking environment, and recommended benchmarking these rates to similar commercial bank deposit rates with a positive margin of 50 basis points. To avoid frequent changes, it suggested that the rates be reviewed only once a year.

Though the government has not accepted the recommendations of the Gupta Committee, it has attempted to align the interest rates structure of the postal savings system with that of the commercial banks and other financial institutions by effecting the first major cuts in deposit rates effective January 1999, and the 2001/02 budget announced further cut in postal savings rates.

1/For details, see, Report of the Committee on Small Savings, Ministry of Finance, Government of India (1991) and Report of the Committee on Small Savings, Ministry of Finance, Government of India (1998).

5. The slowdown in the growth of postal deposits during the 1990s may be attributable to several factors. These include a narrowing of the interest rate differential with bank deposits, the growing popularity of mutual fund schemes, especially those run by the state-owned Unit Trust of India, and the floating by public sector financial institutions of bonds that offer similar tax benefits as postal savings schemes. The more recent pickup in growth may reflect increased efforts by states to mobilize additional financing and tighter application of tax withholding on bank deposits.

6. The administration of the postal savings system is complex and involves several agencies. The Ministry of Finance frames the rules and regulations for the schemes, the National Savings Organization (NSO) under this ministry has responsibility for devising strategies for running the postal savings system, and the NSO is supported by Small Savings Directorates (SSDs) in the state governments (Box VIII.2). The postal savings schemes, however, are operated through the Department of Posts under the Ministry of Communication, which acts as an agent on behalf of the Ministry of Finance and is compensated for the services rendered.

India: National Savings Organization (NSO)

The National Savings Organization (NSO) was set up in 1948 under the Ministry of Finance, to promote business under the postal savings schemes. The NSO not only focuses on strategies to popularize the savings schemes in an effort to increase the deposit base but also advises the government on measures to spread the national savings movement in the country. It has a wide network of offices at state and district levels which work in co-ordination with state government departments, postal authorities, and other non-government organizations for developing institutional arrangements for marketing and taking deposits.

One of the NSO’s major efforts has been the recruitment of a large pool of agents to work on a “door-to-door” basis with potential depositors. At present there are about 232,000 agents under the Standardized Agency System (SAS), and about 168,000 agents under Mahila Pradhan Kshetriya Baachat Yojana (MPKBY), who receive commissions based on the amount of deposits they raise. The MPKBY is an agency scheme, exclusively for educated unemployed women to supplement their family income. Commissions are paid to these agents primarily by the Post Office Savings Bank, rather than by the NSO.

Over the years, the NSO’s role as the prime intermediary in the national savings movement has eroded. The state governments, which had no direct role in the process of deposit mobilization in the initial years, have become actively involved so as to maximize the postal savings funds that they use to finance their deficits. Beginning in the mid-1980s, state governments started their own Small Savings Directorates (SSDs) at the state level and set up supporting institutional arrangements in the villages. The SSDs, which often have functional overlap with the NSO, have now largely taken over the field jobs, including the recruitment of agents and the provision of extra commissions (above those paid by the center). Thus the responsibility of mobilizing savings has gradually shifted in favor of the office of the District Magistrate/Collector, who has the responsibility to meet the target deposit mobilization set by the SSD, and away from the District Savings Officer who represents the NSO.

The active participation of state government agencies has limited the role of the NSO whose functions are now more advisory in nature, although it continues to play an active role in the few states that have not set up their own SSDs. In light of the very limited role now being played by the NSO, the central government’s 2001/02 budget announced that the institution would be downsized to 25 staff from its current staff strength of 1,191.

B. Financial Products

7. There are currently seven types of postal savings schemes, six of which offer tax rebates (Box VIII.3 and Table VIII.1). The bulk of the deposits are mobilized through the KVP and the National Savings Certificate (NSC), which target higher-income groups and offer very attractive returns. Under these two schemes, which accounted for 62 percent of outstanding deposits in March 1999, depositors are issued certificates, and are not required to open accounts with the Post Office Savings Bank.3

Table VIII.1.

India: Amount Outstanding under Postal Savings Schemes

article image
Source: Reserve Bank of India, Handbook of Statistics on Indian Economy 2000.

8. The KVP scheme is the most popular, accounting for 45 percent of deposits in 1999. The scheme has historically offered high nominal interest rates, with the initial deposit amount typically doubling by maturity.4 In addition, KVP deposits are highly liquid and can be pledged as collateral for loans from commercial banks. The scheme does not offer any tax exemptions and is popular among farmers whose income is tax-exempt. However, it has also attracted high-income investors outside the farm sector, possibly as a vehicle for tax evasion.

9. By contrast, the NSC scheme, which accounted for about 17 percent of postal savings deposits in 1999, provides substantial explicit tax benefits. Not only is interest earned tax free, but 20 percent of initial deposits (subject to an annual maximum) can be applied as a tax credit. Furthermore, interest accrued during the first five years is treated as a reinvestment into the scheme and qualifies for an additional tax rebate.

India: The Taxation of Income from Postal Savings

Investments in six of the seven postal savings schemes offer rebates of income tax. The exception is the Kisan Vikas Patra (KVP), which does not offer rebate on income tax since the scheme is intended for farmers whose income is already tax exempt in India.

Interest income earned on the other six schemes is eligible for income tax rebate under two different sections of the Income Tax Act, 1961. Under Section 10, interest income earned from Post Office Savings Account is completely exempt from income tax. Under Section 80L, interest income earned under Recurring Deposit Accounts, Time Deposit Accounts, the Monthly Income Scheme, the National Savings Scheme 1992 (NSS-1992) and National Savings Certificates VIII (NSC-VIII) is tax exempt up to an upper limit of Rs 12,000 per financial year.

In addition, investment in NSS-1992 and NSC-VIII enjoys a tax rebate under Section 88 of the Income Tax Act. Under this provision, the depositor is provided a tax credit of up to 20 percent of the amount deposited, subject to a maximum of Rs 12,000 per annum (in the case of authors, artists, musicians, actors, sportsmen, and athletes, the amount of rebate is 25 percent of the investments subject to a limit of Rs 17,500). Furthermore, annual interest earned from NSC-VIII scheme is recognized as reinvestment for tax consideration under Section 88.

Thus an investment in NSC-VIII scheme (6-year maturity) would enjoy tax rebates from three sources:

  • A 20 percent tax credit under Section 88 in the initial year of investment;

  • A tax exemption on interest income under Section 80L with a cap of Rs. 12,000 per annum; and

  • A 20 percent tax rebate under Section 88 on the amount of annual interest income which are treated as reinvestment.

By contrast, investors in government securities only benefit from tax concessions under Section 80L.

All investments in postal savings schemes (including KVP) are also free from wealth tax.

Tax on interest income is not deducted at source under any of the postal savings schemes. The reporting of such income is left to individual investors when filing their annual tax returns. Furthermore, investors in the KVP scheme may find it particularly easy to hide the total investment amount since they are issued a certificate and do not need to open an account with the Post Office Savings Bank.

10. The other schemes are principally geared toward low- and marginal-income earners. Most popular among these are the Monthly Income Scheme and the Recurring Deposit Account (RDA), which together accounted for about one fifth of outstanding postal savings deposits in 1999. The RDA is a payroll savings scheme (as is the National Savings Scheme 1992 or NSS-1992), which allows both private and public sector wage earners to make automatic investments through monthly salary deductions.

C. Government Policy and Costs of the System

11. The funds raised by the postal savings schemes are made available to the central and state governments as long-term loans. While the system of onlending was revised beginning in fiscal year 1999/2000 with the creation of the National Small Savings Fund (NSSF), the essential features of the arrangement have not changed (Box VIII.4). State governments receive the largest share of postal savings collections (currently 80 percent). Postal savings represent a favorable source of finance—the loans are for 25 years with an initial moratorium of five years on payment of both interest and principal. There are no restrictions on the use of the funds, and the recipient governments tend to use them as general budgetary support. This contrasts with the practice in Japan, where postal saving collections are to be earmarked mainly for infrastructure investment (Box VIII.5). The proportion of the states’ fiscal deficits financed by postal savings collections has risen from about 20 percent in 1979/80 to over 28 percent in 1999/00.

12. Currently the NSSF lends postal savings funds to the central and state governments at a rate of 1214 percent. This rate is set to cover the explicit cost of raising postal savings deposits, which includes interest to the depositors, commissions to the agents, remuneration of the Department of Posts, and the operational expenditure incurred through NSO.

13. Increasing state fiscal deficits during the past decade have spurred efforts by state governments to mobilize postal savings deposits, in order to soften the constraints implied by central government limits on market borrowing. State governments have created small savings directorates and taken various measures to promote deposits. These have included the appointment of Savings Committees at district and block level, which set targets at the village level for which the village extension officer is directly responsible. Progress is monitored in the monthly meeting of the District Savings Committee coordinated by the District Collector. Some of the state governments have offered extra commissions to the agents over and above what is paid by the NSO through the Post Office Savings Bank, and have also used lotteries as inducements to investors. In addition, 400,000 persons across India are employed to collect postal savings, raising concerns that the system is being used to assist low-income households.

India: Loans Against Small Savings Collections1

The accounting of small savings collections in India has undergone changes in the recent past to make the system more transparent and amenable to financial scrutiny. A separate National Small Savings Fund (NSSF) under the Public Accounts of the central government was established with effect from April 1, 1999. Starting in 1999/00, the funds raised through the postal savings schemes are deposited with the NSSF. Principal repayments and interest payments are also made out of this fund, and the balance (net collection) is invested in central and state government securities as per agreed norms. Costs incurred in running these schemes are also charged to this fund.

Under the previous system of accounting, it was difficult to assess the financial impact of small savings on central government finance since small savings transactions were carried out under two separate accounts with different budgetary treatments. Small savings deposits were treated as capital receipts and withdrawals as capital expenditure under the Public Account of India, while interest paid to depositors and the costs of operating the schemes were treated as revenue expenditure under the Consolidated Fund of India. Furthermore, all transactions related to the states flowed through the Consolidated Fund of India, with the center’s onlending of small savings funds to the state governments treated as capital expenditure (and repayment of those loans as capital receipts), while interest paid by the states to the center was treated as revenue receipts. One consequence of this complex system of accounting was that the funds onlent to the states were recorded as a non-plan expenditure of central government; thus any buoyancy in small savings collections led to a rise in the official measure of the center’s fiscal deficit.

Currently, 80 percent of the net collections (gross collections minus withdrawals by depositors) in Small Savings Schemes in each state (50 percent in case of Deposit Scheme for Retiring Government Employees and Public Sector Companies) are invested in the respective state government securities, and the remaining 20 percent (50 percent in case of special deposits) are invested in central government securities. Additional funds are also provided as an incentive to the states depending on their collection performance. Currently, this amount is equal to 2.5 percent of the net collections in the state for every 5 percent increase in the ratio of net collection to gross collection over the all-India ratio of net collection to gross collection.

The government securities (both central and state) held by the NSSF have a maturity period of 25 years with an initial moratorium of five years on interest and principal repayment, and carry a fixed interest rate. The interest rate, currently 12½ percent, is revised periodically and is based on the cost of collection.

1/For further details, see Report of the Committee on Small Savings, Ministry of Finance, Government of India, 1999.

India: The Postal Savings System in Japan

The Postal Savings System in Japan is the largest financial institution in the world, public or private, with an asset base of $2 trillion in 1996. Its deposit base has risen steadily from around 11 percent of bank deposits in 1965 to more than 45 percent in 1996. By contrast, postal savings banks in most Western European countries are witnessing a decline in their deposit base. Countries like the Netherlands, Germany and New Zealand have opted for privatization, while the postal savings system in the United States was abolished in 1966.

The success of postal savings in Japan through the early-1980s was attributed to the attractive features offered by the postal savings instruments. Nearly 90 percent of total postal saving deposits consisted of 10-year teigaku deposits, which offered higher fixed interest rates than commercial banks, tax exemption on interest income (up to specified ceiling), the possibility of withdrawing deposits with only a nominal interest penalty, and an explicit government guarantee. Though the total amount that could be deposited in postal savings accounts by individuals was in principle subject to a nominal ceiling, enforcement was weak and depositors could open multiple accounts and thereby enjoy larger tax benefits.

Under the oversight of the Ministry of Finance’s Trust Fund Bureau, the funds deposited in the postal savings system were channeled—through the Fiscal Investment and Loan Program (FILP)—into the general government sector, government financial institutions, and public corporations. The FILP—often considered the second budget in Japan—supported fiscal policy objectives, in particular infrastructure investment, but also invested funds directly in government bonds. FILP borrowers were charged a low, fixed statutory rate of interest (around 6 percent in the early 1980s).

However, with interest rates witnessing a declining trend in the early 1980s, the system was reformed in several directions. The statutory rate of interest on FILP loans was replaced with a more flexible interest rate that was tied to the prime lending rate. Tax exemptions on interest income were mostly withdrawn, and interest rates on postal savings deposit were set more in line with those in private financial institutions. The changes had the expected effect of slowing the growth of postal savings relative to that of deposits in private banks, and the ratio of postal savings to total deposits declined to around 29 percent in 1990, after having reached 36 percent in 1986.

The shift in deposits to the banking sector was reversed after the Japanese asset-price bubble burst, following a general decline in interest rates amidst weakening economic activity in the early 1990s and the emergence of strains in the banking sector due to a deterioration in asset quality. In spite of better returns offered on some bank deposits, depositors were attracted by the more liquid features of the postal savings deposits as well as the full government guarantee it carried. As a result, postal savings deposits rose sharply, reaching over 45 percent of bank deposits in 1996.

14. The explicit and implicit costs of the postal savings system are considerable. The postal savings schemes offer higher interest rates compared to the commercial banks; tax rebates are provided that raise effective rates of return and lower government revenue; commissions are paid to agents by the central and state governments; and expenses are also incurred for advertisements and other marketing efforts. As a result, the effective cost of these funds is high compared to tapping the debt market directly.5

15. Estimates of the cost of the four main schemes are illustrated in Table VIII.2. Taking into account the tax revenue forgone, commissions paid to agents,6 and the nominal interest rate paid, estimates for the effective interest cost in 2000/01 range from 21.1 percent for deposits raised through for NSC-VIII to as low as 11.4 percent for deposits under the KVP. However, these estimates do not include the administrative cost of running the scheme through the Department of Posts and the NSO. Adding these costs would increase the estimates by close to another 2 percentage points.7

Table VIII.2.

India: Effective Cost of Postal Savings Schemes, 2000/01

(Percent per annum)

article image
Source: Staff estimates. The implicit cost of the tax rebate is estimated by spreading the total rebate amount over the maturity structure of the scheme. The tax rebate is not uniform across deposits since the amount of tax rebate varies based on each depositor’s taxable income bracket. Income tax rates for the fiscal year 2000/01 (inclusive of rebates) were 11 percent, 22 percent, and 34.5 percent.

Estimated at lowest income tax rate of 11 percent and highest rate of 34.5 percent.

Compound interest rate estimated on a maturity of 6 years.

Compound interest rates estimated on a maturity of 4 years.

Post Office Time Deposit. Compound interest rate on 5-year time deposit.

Compound interest rate on a maturity of 6.5 years.

16. Concern has been expressed, including by the Reserve Bank of India, regarding the adverse effect of inflexible returns on postal savings deposits on financial market development.8 In its recent semi-annual policy statements (see, for example, Mid-term Review of Monetary and Credit Policy, October, 1999), the RBI noted that although bank deposit rates were deregulated in 1994, banks were slow to adjust their rates downward for fear of possible deposit flight to the postal saving system. The RBI argued that this has led to a downward rigidity in the interest rate structure.9

D. Reform Considerations

17. It has become increasingly obvious that the current system has significant drawbacks, including with regard to the high cost to the government, the adverse effect on the banking system, and macroeconomic management.10 Important reform issues therefore include the inflexibility of postal saving deposit rates; their tax treatment; the way in which these funds are provided to state and central governments; and the administration of the schemes.

Rate setting

18. Interest rates on postal saving schemes have been adjusted only infrequently. Since the core group of small savers includes vulnerable groups with limited alternative sources of income, the decision to lower rates has been highly politicized. State governments have also resisted reductions in interest rates, on fears that a migration of postal savings deposits to the banks would constrain budget financing.

19. In order to address these concerns, an Expert Committee was struck in early 2001 to review the system of administered interest rates and is expected to report in August 2001. Options that have already proposed to introduce greater flexibility include setting the nominal rate equal to a fixed margin over the inflation rate. The difficulty with this approach—which was described in the January 2001 report of the Prime Minister’s Economic Advisory Council—would be to define the appropriate real interest rate, and to establish the appropriate measure of inflation. An alternative and simpler option might be to follow the recommendation of the Gupta Committee and tie postal savings rates to some market-determined interest rate of similar maturity, possibly the rate of return on the assets in which the deposits are invested.

Tax preferences

20. Since many small savers earn low incomes and typically do not pay taxes, existing tax incentives seem unnecessary, particularly given that interest rates on postal savings remain at least as high as those on other savings instruments.11 Indeed, the existing tax preferences tend to benefit higher-income depositors disproportionately, and are difficult to justify on equity or efficiency grounds. They are also likely to shift deposits away from longer-term investments in provident fund and life insurance schemes. Moreover, in spite of the significant reduction in postal savings rates in recent years, the continuation of the significant tax advantages enjoyed by these schemes tend to reduce the franchise value of banks, which have begun to face increasing competitive pressures owing to deregulation.

21. There is also a need to address the use of the postal savings system as a possible vehicle for tax evasion. Most notably, there is no withholding of tax on interest earned on the KVP scheme, which makes it particularly attractive to higher-income households. Indeed, some analysts have suggested that the recent growth of postal saving deposits has, at least in part, reflected stricter tax withholding by banks. Against this background, there would seem considerable merit in introducing tax withholding on interest paid under the KVP.

State finances

22. The postal savings system has served to soften budget constraints at the state level, thereby undermining fiscal discipline. In particular, while the central government has the ability to limit state borrowing from the market, it is unable to constrain the states’ automatic access to funds that are deposited in the postal saving system. This has facilitated an increase in state government deficits, and a rapid build up of state debt, with pressures now by the states for debt relief.12 Hardening the states’ budget constraints by limiting access to postal savings finance would complement the center’s initiatives to increase fiscal responsibility at the state level. One option would be to adjust state government borrowing ceilings for unbudgeted borrowing against postal savings schemes. An alternative would be to eliminate the central and state governments’ automatic access to these funds, and require the funds to be invested in marketable—rather than special issue—government securities.

Simplifying administration

23. There would seem considerable scope for reforms to simplify the administration of the postal saving system. Although the principal responsibility for the postal savings schemes lies with the NSO, the system is operated by the Department of Posts, with the state government agencies also playing an important role. Significant efficiency gains could be achieved by doing away with the multi-agency approach, providing responsibility for the entire system to the Department of Posts, and running the system on a commercial basis. This would allow a careful reconsideration of the significant commissions paid to agents for attracting deposits. Moreover, the use of the system as a vehicle for promoting employment for economically-disadvantaged persons should also be reconsidered (Box VIII.2)—it would be preferable to provide such support transparently through the government’s budget.

Maturity mismatch

24. Funds directed toward the states through the postal saving system also imply a substantive maturity mismatch. Loans to the states from the NSSF carry a maturity of 25 years, while the average maturity of postal deposits is in the range of five years. Thus, while the annual yield on the two instruments is similar, the difference in maturity leaves the government highly exposed to shifts in investor preference or yields. This suggest the need to bring the maturity of NSSF loans to governments in line with the maturity of deposits; i.e., to five years. Reform of the system could be complemented by other measures such as allowing postal saving deposits to be managed by professional money managers, and to be invested in both government and private securities.

25. Many of the reform issues discussed above are similar to those that have been tackled recently by the Japanese postal savings system. In particular, the Japanese government has introduced a number of reforms geared toward making the system more dynamic and consistent with a free market environment. These include measures to increase the flexibility with which postal saving rates are set; to reduce the tax benefits applying to postal saving deposits; to increase the efficiency of the system by better product design and delivery; and to liberalize the portfolio choices available to the system.

E. Conclusion

26. The current postal saving system has represented an important means of mobilizing savings, especially in rural India, and has provided a captive source of fiscal financing. However, these funds are expensive, owing to their significant tax advantage and the operational inefficiencies of the system. Moreover, the automatic provision of these funds to the states has undermined fiscal discipline and exposed the system to a significant maturity mismatch. The inflexibility and generosity of the rates paid on these deposits has also tended to undermine broader financial reform efforts.

27. Looking ahead, there would appear considerable scope to reform the postal saving system by reducing these tax advantages and increasing the flexibility with which deposit rates are adjusted. More fundamental reforms could also include revamping the administration of the system in favor of the establishment of a single agency responsible for operating the postal savings schemes, preferably on a commercial basis.


Prepared by Sudip Mohapatra.


This chapter excludes small savings schemes run outside the exclusive purview of the Post Office Savings Bank such as the Deposit Scheme for Retiring Government Employees, the Deposit Scheme for Retiring Employees of Public Sector Companies, and the Public Provident Fund scheme. These schemes are largely administered through the commercial banks.


The IVP was the first certificate scheme designed to attract deposits from high-income groups. However, it fell out of favor after the introduction of the KVP (which had better liquidity features), and was discontinued in July 1999.


Prior to 1999, the certificate offered to double the initial deposit amount in 5½ years implying a compound annual interest rate of 13.4 percent. Following the recommendations of the Gupta Committee, the interest rate on the KVP was reduced on January 1, 1999, in line with rates offered by the public sector financial institutions, so that the certificate matured in 6 years. With the most recent cut in postal savings rates (March 1, 2001), the certificate matures in 7¼ years.


Mohanty, M. S., and N. Raje, 1998, “Effective Cost of Small Savings,” RBI Occasional Paper, Vol. 19 No 3, September.


The cost of commissions, which are paid once to the agents when the deposit is raised, is estimated by spreading the amount of the commission over the maturity of the scheme. The commission rates are as follows: (i) for Post Office Savings Account no incentive is paid; (ii) for Recurring Time Deposit the commission is 4 percent on the amount of deposit (exclusively for MPKBY agents); (iii) for Post Office Time Deposit, Post Office Monthly Income Scheme, NSC-VIII, NSS 1992 and KVP, the commission is 1 percent of the amount of deposit; and (iv) for Deposit for Retiring Government Employees and Deposit for Retiring Employees of the Public Sector Companies the incentive is 0.5 percent of the deposit amount. These do not include extra commissions paid by state governments to agents for large deposits.


This is calculated for 1998/99 by dividing the reimbursement paid to the Department of Posts by the Finance Ministry (Rs 9,698 million) plus the cost of running the NSO (Rs 158 million) by the gross collection of postal deposits (Rs 548.3 billion).


Similar concerns have been expressed regarding other government contractual savings schemes, e.g., the Public Provident Fund scheme (PPF), the General Provident Fund scheme (GPF), and the Employee Provident Fund scheme (EPF).


The central government responded to these concerns by cutting administered interest rates around budget time in each of the last three years. While the differentials between interest rates on postal savings schemes and commercial bank deposits have narrowed, the administered rates on government sponsored saving instruments continue to imply a lower bound for bank deposit rates.


See the Report of the Prime Minister’s Economic Advisory Council, January 2001 and the 2001/02 Budget Speech.


Similar recommendations are made in the Shome Report of The Advisory Group on Tax Policy and Tax Administration for the Tenth Plan (Planning Commission, May 2001), which argues for the abolition of various incentives under the Income Tax Act, including those under Sections 88 and 80L.


The states have suggested a number of options including: (i) treating small savings loans as loans in perpetuity; (ii) a complete write-off past loans (principal and interest); (iii) waiving or reducing past interest; (iv) providing future loans interest-free or as grants. These options were generally rejected by the recent report of the Eleventh Finance Commission.