Small Savings, Big Problem – India Must Move On From This Costly Legacy

India’s small savings schemes have outlived their original purpose. Once designed to foster a culture of thrift and provide the government with an alternative funding source, they are now an expensive legacy liability. Their cost has ballooned, distorting market interest rates and complicating fiscal management. 

It is time to reconsider their role in a modern, market-driven economy.

Small savings schemes have a long history, dating back to the colonial era when the Post Office Savings Bank was established in 1882. In post-independence India, these instruments—including the National Savings Certificate, Kisan Vikas Patra, and Public Provident Fund—were critical in mobilising resources for nation-building. They were particularly useful at a time when the banking system was underdeveloped and financial inclusion was a distant dream.

That is no longer the case. India is no longer an under-banked country. Bank penetration has surged, with the number of deposit accounts per 1,000 people rising from 43 in 1972 to over 1,600 in 2022. More importantly, administered interest rates do not go well with a deregulated, market-determined interest rate system. The original justification for small savings schemes—providing a safe savings vehicle for those without banking access—is now redundant. Yet, instead of winding them down, the government has been leaning on these schemes as a key funding source for its fiscal deficit.

Expensive Option

The cost of borrowing from the National Small Savings Fund (NSSF) is higher than what the government would pay in the bond market. In 2023-24, the Centre borrowed at an average rate of 7.24% in the bond market, while loans from the NSSF carried a higher rate of 7.7%. For states, the mismatch was smaller but enough for most to opt out of the scheme altogether. Since 2016-17, all but four—Arunachal Pradesh, Delhi, Kerala, and Madhya Pradesh—have chosen cheaper market borrowings.

With states stepping back, the Centre has had little choice but to absorb more of the burden. In 2014-15, small savings accounted for just 6.3% of the Centre’s fiscal deficit. By 2023-24, that figure had soared to 27.3%. For 2024-25, the Centre is set to borrow ₹4.20 trillion from small savings—an inefficient financing choice at a time when India’s sovereign credit profile has improved.

The high administered interest rates on small savings schemes have another unintended consequence: they act as a floor for bank deposit rates. This limits monetary policy transmission, making it harder for the Reserve Bank of India to influence interest rates. Banks are forced to compete with these government-backed instruments, often offering better rates regardless of market conditions.

Further, the government has used the NSSF for off-budget financing. In the past, it lent to the Food Corporation of India to cover food subsidies, masking the actual fiscal deficit. This practice ended in 2020-21 when the government repaid FCI’s ₹3.39 trillion in outstanding NSSF loans, causing the fiscal deficit to jump to 9.2% of GDP. While this cleaned up the books, it left the NSSF with fewer lending options, making the Centre its de facto borrower of last resort.

Necessary Phase-Out

India no longer needs small savings schemes in their current form. The government should start transitioning from them by gradually reducing the administered interest rates and capping inflows. Encouraging greater participation in market-based investments, such as sovereign bonds and mutual funds, would be a more efficient way to mobilise household savings.

The political challenge is real. No government wants to be seen cutting returns on savings instruments that millions of middle-class Indians rely on. Any move to phase them out or reduce interest rates would risk a backlash from retirees, salaried workers, and small business owners who see these schemes as a safe haven. Another challenge lies in the country’s savings rate. Small savings schemes are crucial to household savings, particularly for retirees and low-risk investors. If they are phased out, some portion of savings could shift to consumption, reducing household savings, which is the most significant component of Gross Domestic Savings. State-owned banks could develop some schemes here to provide a transition phase. 

The economic case is clear: small savings schemes distort financial markets, add to the fiscal burden, and prevent India from moving toward a fully market-driven interest rate regime. The time to rethink them is now and move away in a phased manner.