PPF rate increase to 8.6%--should you be worried?

Till now, it was easy to project and build a corpus using the fixed rate offered by PPF—the best instrument till 30/11/2011 offering tax free 8% p.a.

Traditionally the future projections for PPF corpus, a product with 15 year maturity period, revolved around an approximate annual compounding return of 8 per cent. Most people use their provident fund for purposes such as children’s marriage, higher education, or buying a house. 

Not any more!!

Effective 01/12/2011, Government of India made the following changes with regard to small savings which will impact those who prefer fixed return instruments --in particular PPF investors:-

• PPF rates increased to 8.60%
• Investment limit raised to Rs. 1 lac from present Rs. 70000
• Interest on loan from PPF balance raised to 2% from 1%.
• Commission on PPF deposits abolished.
• Maturity period of NSC and MIS reduced to 5 years.
• Maturity bonus of 5% on MIS scrapped.
• Kisan Vikas Patra (KVP)—a preferred instrument for money launderers—scrapped.
• THE ERA OF FIXED RATE IS GONE! Yes, you read it correctly. The Government has made returns from PPF market linked. Interest on PPF would now be linked to the G-Sec of similar maturity with a positive mark up of 0.25%.

The applicable annual interest rates will be notified by the government before 1^st. April every year.

How will this affect the aam aadmi?

The government’s move implies that it wants the investor to bear the burden of risk of interest rates movement while enjoying the tax breaks.

Being market linked, the rate of return would come down whenever there is a downward revision of interest rates, making it difficult for a person to work towards a long term financial goal, like building retirement corpus, through instruments like PPF.

The strongest message of this move is: - the era of fixed rate of return has in India ended and supremacy of market forces enforced.