The Economic Advisory Council to the Prime Minister has just handed in its advice. Among the important policy recommendations – get the Ministry of Finance (MoF) fast out of the interest setting business i.e. administered interest rates on small savings and provident funds (hereafter SS) should be cut by 2 percent.

What has not been clear all these years (at least to me) is why would government deliberately borrow at a higher rate of interest than necessary ? By mandating tax free deposit rates at 11 percent (and a pre-tax rate upwards of 14 percent), and with core inflation less than 4 percent, why would the government decide to pay small savings investors a premium over anything risk-free available in India or the rest of the civilized world ? Phrased differently, who gains from the perpetuation of the status quo? Clearly not Ram, Shyam or Sita, nor the corporates who, thanks to WTO, no longer can demand goodies through high and higher tariffs. To be sure, there have been rumblings about what is the poor "small" saver going to do. This is akin to mutterings about what will the poor member of Delhi Golf Club do if the government were to charge a land tax or any tax on golf associations!

There is a major, mega, beneficiary from the existing status quo on small savings instruments - state governments. But why is a borrower, albeit state governments, happy at borrowing at 12.5 percent today ? (The saver gets a tax-free rate of 11 percent, and the state government pays 12.5 percent, the difference being made up by central government costs). Would not the states be better off paying an interest rate of only one or two percent above inflation? It would, but then it won't have a large piggy bank of its own.

The reality is that the small savings deposits are used by state governments for all kinds of purposes - among which are items like meeting salary expenses, using deposits as a collateral for state enterprises who in turn obtain bank loans for state governments to finance current expenditure, and so on. In other words, a chit-fund, a very very large chit-fund, personified.

But what is the problem with state governments using SS deposits as their private depository ? After all, fully 80 percent of these deposits are "theirs" with the remainder available to the Centre. The only problem is that it appears that in order to meet their pressing needs, the states are resorting to giving large incentives to savers to park their savings temporarily (for considerably less than a year) with the SS bank. This is in clear violation of laws which prohibit SS deposits to be parked for less than a year - indeed, most deposits are for a duration longer than 2 years.

But what evidence is there for the above "speculation"? The evidence comes in the form of two reports of the Reserve Bank of India Bulletin dated Dec. 1999 and Dec. 2000. These reports contain details of new deposits and accumulated debt of the small savings operation. The data for some of the important categories are contained in the table; the December 1999 data is labeled as Old and Final, and the December 2000 data as New and Preliminary. Why this strange data behaviour, where 1996 to 1999 data was final in Dec. 1999 and preliminary a year later is, well...

A strange thing happened with SS data reporting at the mother of all banks. In it's Dec. 1999 report, the RBI reported a huge, Rs. 130,000 crore SS deposits for 1997-98, a level about Rs. 114,000 crore higher than the year earlier (1996-97) level. That this was no typo was indicated by the reported magnitude of Rs. 166,000 crore deposits in 1998- 99. Since the deposits are meant to be for at least one year, the "outstandings" should also show a jump - but they don't. Despite a 114,000 crore jump in 1997-98, outstandings increase by only Rs. 6,500 crore. So what is going on ?

Unclear. However, subsequent to the Dec. 1999 figures (which I tried to discuss with MoF officials in Jan. 2000 but was told that only outstandings as of March 31st. of each year were under its purview - and these were showing nothing fishy so what was the problem ?) the RBI stopped publishing the old and final figures, and started labeling all figures since April 1996 as preliminary! These "new" deposit figures are consistent with the outstandings, so everything is hunky-dory. Almost. For apparently, the RBI does not feel that it has to publish any figures later than March 1999 i.e. there have been no updates to the data since Dec. 1999.

It is apparent that RBI knows there is something wrong, as it is apparent that the MoF knows there is a serious problem. What is likely happening is the following. The fiscal deficit of the states has galloped from Rs. 37,000 crores in 1996-97 to Rs. 95,000 crore three years later. At this pace... But unlike you, or me, or the Central government, the states do not go to the market to borrow for their excesses. Indeed, in a classic set up of non-market regulations which incite citizens (and governments themselves) to cheat, the states are not allowed to borrow from the market. They have only three sources for borrowing for their deficit - loans from an increasingly stingy center, market borrowings on behalf of state PSU's, and chit funds (small savings and provident fund deposits). With generous pay commission awards, and no productivity and extra revenue growth to speak of, the states saw their revenue increase by a paltry 15 percent from 1996-1997 to 1998-99. Expenditures increased by a whopping 32 percent, and the deficit by a hundred percent. No rocket science debt math here - just plain numbers. In absolute terms, the deficit went up by 37,000 crores.

Surely, such a large increase in borrowings with no known source for borrowings can cause ingenuity to work overtime. Well, why not tap into the neighborhood piggy (savings) bank ? Borrow for month to month expenditure, give large commissions to agents bringing in savings, do not charge more than a nominal penalty for early withdrawals, and borrow like mad. Make sure outstandings are clean at the end of every March (remember - figures have to be vetted by the MoF and parliament) and no one is the wiser. Except the RBI in a mistakenly published, and honest, Dec. 1999 Bulletin.

What is the cost to you and me ? The gross deposits for the year are about Rs. 180,000 crores today, net deposits about Rs. 50,000. An additional temporary borrowing of Rs. 130,000 crores at a pre-tax rate of 14.5 percent yields approximately Rs. 15,000 crores a year -or Rs. 60,000 crores extra during the last four years.

The solution - let the centre, and state governments, borrow from the market - the only transparent method available. And RBI can go back to reporting honest, and latest, figures. And the economy will face 4 to 6 percent lower interest rates. And India's ambitions can begin to match the reality of a 9 percent plus GDP growth.