Thursday, January 28, 2016

[Editorial # 52] No small trouble : The Indian Express

[Following editorial has been published in The Indian Express on 28th January 2016. Read through it and try to answer the questions that follow. Please do not copy and paste answers. The objective of this exercise is to get you in the groove of answer -writing. Try to write in your own words. Don't hesitate to write in a bulleted-format, if you are uncomfortable in writing in paragraph form.]

Even as RBI Governor Raghuram Rajan is set to present his next bi-monthly monetary policy review early next week, there is increased focus on what is to be done with the interest rates on small savings instruments like the public provident fund (PPF), the national saving certificate or the new Sukanya Samriddhi Account Scheme (SSAS). Currently, there’s a significant gap between the rates paid on these — ranging from 8.7 per cent for PPF and 9.2 per cent for SSAS — and the 7-7.5 per cent banks give on deposits or the 7.8 per cent yields on 10-year government bonds. The economic case to align the administered rates on small savings with the rates prevailing in the market is obvious. Such a gap essentially incentivises people to put their money in the small savings instruments, while making it difficult for banks to reduce deposit rates and, in turn, lower lending rates that are much needed in the current investment-starved economic environment.

Over the last year, the RBI has cut its policy rates by 125 basis points, whereas banks have on average reduced their lending rates by just half of that. Economists are not wrong in pointing out that the high administered rates for small savings — in relation to both market rates and CPI inflation — act as effective impediments in the “transmission” of the RBI’s monetary policy signals. To that extent, any further repo rate cuts — even assuming it happens on February 2 — will have only a limited impact on what companies and individuals would pay for their loans from banks. One could also very well argue that the overall gains to the economy from lower interest rates will far outweigh benefits to small savings deposit holders, who are today receiving real interest rates of 3 per cent after adjusting for inflation. They will continue receiving inflation-beating returns even if rates on PPF deposits are cut by 1 per cent. But selling this politically is another thing.

What can be done? Ideally, the government should follow the report of the Shyamala Gopinath committee that, in 2011, had suggested fixing small savings rates based on “a positive spread of 25 basis points, vis-a-vis government securities of similar maturities…” One way to make it politically more palatable could be to retain the current rates only for deposits below a certain limit. But ultimately, this is a political call the government cannot delay too long. It’s unlikely to encounter much resistance here from states, which are less reliant on small savings collections following the Centre’s decision to devolve an increased share of its tax revenues.

Questions:

1. What are the various roles and functions of RBI? How are these functions different from those of the Ministry of Finance?

2.  What is meant by Small Savings Instruments? What are various such instruments available in India?

3. What is Sukanya Samriddhi Account Scheme (SSAS)? What are its features?

4. What are Government Bonds? Can you buy/sell government bonds? How?

5. Why should the administered rates on small savings be aligned to the market rates?

6. Why is the government hesitating to reduce the rates on small savings schemes?

7. When does the RBI hike and decrease the interest rates? What impact does it lay on the economy?

8. What is meant by policy rates? By whom and when are these rates determined?


9. Why was Shyamala Gopinath Committee constituted? What were its recommendations?

10. Explain the following terms (50 words):
  • Repo Rate
  • Basis Point
  • Tax revenue
  • Government Securities
  • Real Interest Rate



26 comments:

  1. 1. What are the various roles and functions of RBI? How are these functions different from those of the Ministry of Finance?
    A.RBI was established on the recommendations of the Hilton Young commission at kolkata which later moved to mumbai, the financial capital of india.
    ECONOMIC ANGLE:
    the following are the roles of RBI:
    1. to control the inflation through the monetary policy instruments like BR, RR, RRR, CSR etc.

    2. to be a banker's bank
    3.as a banker to the government of india
    4. functions as clearing house
    5. print currency and coins whenever needed
    POLICY measures:
    advisory role to the GOI
    to provide the stablility in the economy
    to curb the corruption and money laundering
    DEVELOPMENTAL ROLE:
    to provide cheaper loans to the citizens indirecly through monetary measures
    to estb financial ins of national importance: NABARD, IDBI etc
    collection and publication of data.

    FINANCE MINISTRY has 5 departments under its head:
    1. Dept of revenue: CBDT and CBEC plays crucial role in assisting this department which were constituted under central board of revenues act, 1963
    2. Dept of Expenditure:obj is to optimise the o/p and expenditure of the GOI.
    3. Dept of financial services: started PMJDY
    4.Dept of economic affairs: to look after the aspects of economy. formulation of budget, raise money from external sources .
    5. dept of disninvestment: deals with privatisation and psu etc

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  2. 2. What is meant by Small Savings Instruments? What are various such instruments available in India?
    A.small savings instruments are the investments which are not only safe and secure but also gives stable returns.The following are the various SSI in india
    1. kisan vikas patra
    2. National savings certificate
    3. senior citizen saving scheme
    4sukanya samridhi yojana
    5. PO tiem deposit
    6. public provident fund etc.

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  3. 3.What is Sukanya Samriddhi Account Scheme (SSAS)? What are its features?
    A. Our honorable PM after launching beti bachao beti padao scheme has announced this SSAS for the child as account holder and guardian as investor to facilitate decent amount of money during the child;s marriage or for higher education as per the needs.
    the following are the features:
    1. child of any age can be an account holder
    2. investment limit to be of 1000-1.5L with Interest rate of 9.1%
    3. tax exemption under 80C
    4. duration scheme is for 21 years. Premature money can be drawn after 18 years
    5. both interest and maturity proceeds are not taxed.

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  4. 4. What are Government Bonds? Can you buy/sell government bonds? How?
    A. govt bonds are issued by the GOI with a promise to pay interest with the face value on maturity date. The govt issue bonds to raise capital. Yes, i can buy govt bonds. I hve to go to the nearest banks or post offices which are desingnated with app and submit a filled up app form.

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  5. 5. Why should the administered rates on small savings be aligned to the market rates?
    A. As banks are loosing much of the monney in providing high IR to the small saving account holder,which is a priority sector lending, as fixed deposits of banks becomes uncompetitive which inturn affets the investment proportion of banks. Hnece , the rates have to be reduced to the market rates .

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  6. 6. Why is the government hesitating to reduce the rates on small savings schemes?
    A. The intention of govenment is to increase the domestic savings of the india to face any challenges in the future such as economic slowdown, inflation, etc.To encourage the small savings schemes which inturn builds the economic stability of the nation is the approach of govt not to reduce the IR, which driveout the money from small savings.

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  7. 7. When does the RBI hike and decrease the interest rates? What impact does it lay on the economy?
    A.RBI is entrusted with the responsibility to control inflation and promote employment . The IR s are varied to maintain stability in the economy.
    CASE 1:-
    whenever there is lack of employment oppurtunities which reduces production and hence the goods and services are less in the market. This means there is an increase in the demand. Now RBI jumps into the picture by reducing the IR. Hence more people will avail the loans for production and consumption . for instance when the IR in realestate is reduced, investors who construct flats will avail loans and the consumers who purchase the flat will also avail the loan. Hence, the money is pumped into the market. This real estate will trigger the economy of cement, bricks, electricity appliances and all other items in the houses. thus economy will flourish .
    CASE 2:-when will the RBI increases the IR? this is when there is excess money in the market due to which the demand for prices are going up. this is because so much money is chasing fewer goods. Now to curtail the inflation RBI increases the interes rates to demotivate the production cycle. Those who cannot afford to take a loan will wait for a time when the IR will be reduced.Now the catch is people stop to buy things but start depositing in the banks as the returns are high. Here the money is sucked from the market.

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  8. 1. Roles of RBI in the Indian Economy. Major roles of the RBI: -
    The Reserve Bank of India has the sole right to issue currency notes except one rupee notes which are issued by the Ministry of Finance. Currency notes issued by the Reserve Bank are declared unlimited legal tender throughout the country.
    As banker to the government the Reserve Bank manages the banking needs of the government. It has to-maintain and operate the government’s deposit accounts. It collects receipts of funds and makes payments on behalf of the government.
    The commercial banks hold deposits in the Reserve Bank and the latter has the custody of the cash reserves of the commercial banks.
    The Reserve Bank has the custody of the country’s reserves of international currency, and this enables the Reserve Bank to deal with crisis connected with adverse balance of payments position.
    The commercial banks approach the Reserve Bank in times of emergency to tide over financial difficulties, and the Reserve bank comes to their rescue though it might charge a higher rate of interest.
    Since commercial banks have their surplus cash reserves deposited in the Reserve Bank, it is easier to deal with each other and settle the claim of each on the other through book keeping entries in the books of the Reserve Bank. The clearing of accounts has now become an essential function of the Reserve Bank.
    Since credit money forms the most important part of supply of money, and since the supply of money has important implications for economic stability, the importance of control of credit becomes obvious. Credit is controlled by the Reserve Bank in accordance with the economic priorities of the government.
    Differences between RBI and the Finance Ministry: -
    Finance Ministry (FM) is entirely controls the fiscal system of the government. it is the centralised form of market determinant which directs the market fiscally on the will of the government. RBI, on the flipside, works independently and raptly concerned about the monetry policies of the country or the government. RBI is governed by the govenor not by any elected minister of the cabinet.
    It governs the expenditure department of government, which mainly deals with the transfer of resources across the states in India.
    This department (department of expenditures) looks after the proportionate distribution of revenue between the central and the state government, as per the constitutioinal directives in the financial matters. RBI has nothing to deal with the revenue distribution between governments.
    The chief sources of revenue or Union tax include customs duties, income taxes, corporate taxes, and union excise duties. Revenues that belong to the non-taxable group consist of interest receipts such as the interest sum paid by the railways and telecommunications sector along with dividends and profits. The important revenue-earning units are the taxes and duties paid by various state governments, taxes and grants received from the Union, and other local taxes such as property taxes and terminal taxes.

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    Replies
    1. nice explanation. If structure is there it would be more attractive

      Delete
  9. 3. Sukanya Samaruddhi Account Systyem (SSAS)
    This scheme is designed in order to target the parents of the female child or girl ONLY. This scheme is majorly concerned to encourage the parents to get the fund for the education and for the marriage of the girl. this scheme is launched under the beti bachao, beti padhao campaign started by the Modi Governement in 2015 January. this scheme will lend the money at 9.2% of interest rate. To register for the scheme, parents can open their accounts at any authentic or authorised commercial bank and even through any post office banks.
    A minimum of Rs.1,000 must be deposited in the account annually. The maximum deposit limit is Rs.1,50,000. If the minimum deposit is not made in a year, a fine of Rs.50 will be levied. The girl can operate her account after she reaches the age of 10. The account allows 50% withdrawal at the age of 18 for higher education purposes. The account reaches maturity at the age of 21. If the account is not closed, then it will continue to earn interest at the prevailing rate.If the girl is over 18 and married, normal closure is allowed.
    FEATURES OF THE SCHEME: -
    ELIGIBILITY - Girl child only, Citizenship: Child should be Indian citizen, Age limit: On the date of opening the account, the child’s age should 10 years or younger.
    Investor: Parent, or Legal Guardian of the eligible Girl child.
    Operation : - The account will be opened and operated by the guardian of a girl child till the girl child, in whose name the account has been opened, attains the age of 10 years. On attaining age of 10 years, the girl child may herself operate the account.
    Tenure : Deposit needs to made until 14 years from opening of account. Deposit under scheme will mature 21 year after opening of the account.
    Termination : - Scheme Tenure is 21 years from date of opening, or when the marriage of the girl child happens; whichever happens earlier. Account will compulsorily have to be closed after marriage of the girl child. In case after maturity of the account (21 years) the girl child does not marry, and if account is not closed after maturity, balance will continue to earn interest as specified for the scheme from time to time.
    Tax Benefit: Amount deposited is fully tax free and under Section 80C upto Rs 1.5 lacs limit. Which also includes other deductions under Sec 80C. Maturity amount and interest earned is also tax free.
    SSY account can be opened at any commercial bank or post office by paying cheque, cash or demand draft.

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  10. 9. (MOSTLY REFERRED FROM THE INTERNET)

    SHYAMALA GOPINATH COMMITTEE: -

    The terms of reference of the Committee include review of the existing
    parameters for the small saving schemes in operation and recommend mechanisms
    to make them more flexible and market linked. The review of the existing terms of the
    loans extended from the NSSF to the Centre and States and recommend on the
    changes required in the arrangement of lending the net collection of small savings
    to Centre and States. The review of the other possible investment opportunities for the
    net collections from small savings and the repayment proceeds of NSSF loans
    extended to States and Centre. The review of the administrative arrangement including
    the cost of operation and review of the incentives offered on the small savings
    investments by the States.
    RECOMENDATIONS: -
    The committee would help investors earn higher interest on small savings schemes such as public provident fund and post office deposits. The schemes are now under the market-linked interest rate system.
    One of the most significant recommendations by the Shyamala Gopinath panel was making the returns of small saving schemes market-linked. This means that now from this financial year, the rates for small saving instruments will be benchmarked to those of government securities (G-secs) of similar maturity periods with a positive mark-up of 25 basis points (bps). However, for Senior Citizen’s Savings Scheme (SCSS), the mark-up is 100 bps and for the new National Savings Certificate (NSC) with a tenor of 10 years, the mark-up is 50 bps. So if a 10-year G-sec yields 8%, then the rate of interest for Public Provident Fund (PPF) would be 8.25%, 8% plus a mark up of 25 basis points. The government would notify the interest rates applicable for the year on various instruments before 1 April every year.

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  11. 2. Small savings schemes have always been a crucial source to mobilize household savings. Small savings schemes are classified under the following head a) postal deposits which include recurring deposits, time deposits, savings account, and monthly income scheme b) savings certificate such as National Small Savings Certificates (NSC) and the Kisan Vikas Patra (KVP)c) and social security schemes such as the public provident fund and the the Senior Citizens Small Savings Scheme (SCSS). The National Small Savings Fund (NSSF) was established in Aril 1999 and all its collections are credited to this Fund, and all withdrawals are done from this Fund as well.

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  12. 10. Explain the following terms (50 words):
    • Repo Rate: It is the rate at which the RBI lends money to the Banks against securities for a short time.
    • Basis Point: It is a unit of measurement to describe the percentage change in the value or rate of a financial instrument.
    • Tax revenue: It is the income earned by the Government through collection of taxes.
    • Government Securities: It is generally a bond issued by the Government with a promise of repayment upon maturity. It may be issued by the Government itself or one of its agencies.
    • Real Interest Rate: The interest rate which has been adjusted to remove the effects of inflation to reflect the real cost of the funds borrowed by the debtor.

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  13. 9. Why was Shyamala Gopinath Committee constituted? What were its recommendations?
    The Committee was constituted in 2011 to review the small investment schemes of post offices and banks which would help investors earn higher interest on smaller savings scheme. Its key recommendations were:
    i) Discontinuation of the popular Kisan Vikas Patra.
    ii) 0.5% rise in the interest rate for post office savings account to 4% reduction in the maturity period of National Savings Certificates to five years from six.
    iii) Rise in annual contribution limit to the Public Provident Fund to Rs. 1 lakh from Rs. 70,000.
    iv) Interest on loans from PPF raised to 2% per annum from 1%.
    v) New National Savings Certificate to be cut to 5 years from 6 years.
    vi) Interest rates on post office savings to be raised to 4% from 3.5%
    vii) Commission on all other schemes except the Mahila Pradhan Kshetriya Bachat Yojana NSC, MIS maturity period set to be reduced to 5 years.

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  14. 1. The Reserve Bank of India as the Central Bank of the country is an independent body that regulates monetary policy. The Reserve Bank regulates the supply of money in the economy, in other words, the circulation of money in the economy, through changes in the interest rate structure. The functions and powers of the RBI are independent of interference of the Finance Ministry. The RBI prescribes the rules and regulations with regard to establishment, expansion, liquidation , restructuring , amalgamation and closure of banks. It lays down the conditions by which the banks must abide including, the cash reserve ratio (CRR), the Statutory Liquidity Ratio (SLR), and the Capital reserve etc... in order to ensure proper working of the banks and the protection of the interests of the citizenry who utilize the services of the bank. Through the Repo (Repurchase) agreements, the RBI fixes the Repo rate, which is the arte at which the RBI lends money to the commercial banks. When the repo rate is increased, the cost of borrowing rises, and banks pass on this increased cost to their customers as well. There is a decrease in the availability of money in circulation in the economy and prices/ inflationary tendencies show a decline. Similarly an easing of the repo rate signifies that borrowing from the RBI has become cheaper, and such lower rates are theoretically passed on to the consumers. Since credit is cheaper, investors take more loans, and the amount of capital investment, and money in circulation rises, thereby improving prices and giving a boost to the economy.
    The Finance Ministry as an organ of the Central government is in charge of fiscal policy which deals with revenue and expenditure of the government. The Central Government receives revenue in the form of both direct and indirect taxes and spends this revenue for public utilities, investments, and social welfare programs. When the expenditure of the government exceeds its revenue it faces a fiscal deficit and when revenue collections surpass the governments expenditure on public services, it is a revenue surplus. The finance ministry therefore deals with the government's finances. It can establish the tax rates of both direct and indirect taxes, impose surcharges or cess , duties on imports and exports of products, etc... These are all methods of raising income for the government. At the same time it prepares budgets to lay down its expenditure on different sectors such as education, health, infrastructure etc... which are all provided by government institutions. The Indian government spends a great deal of its revenue on providing subsidies to the weaker sections of society so as to ensure equity of growth and development.

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  15. 8. What is meant by policy rates? By whom and when are these rates determined?
    Also called ‘signalling rates’, policy rates are monetary tools used for controlling inflation, determining day-to-day liquidity operations and for determining other market rates. These are repo rate, reverse repo rate, marginal standing facility rate and bank rate. These are determined by the Reserve Bank of India bi-monthly adjusting to various factors in the global and Indian economy.

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  16. The government and the RBI can cooperate so as to align the fiscal and monetary policies so as to give coherence to the manner in which the economy progresses. For example, during an inflationary period, fiscal and monetary policies can be used simultaneously to counter inflationary trends. In such a scenario the RBI could increase the repo rate so as to curtail the quantum of money in circulation whereas the Finance Ministry could either raise the amount of taxes collected both directly and indirectly, although this may be politically infeasible. Similarly , in the recent past, the RBI has been the chief source of government debt financing through issuance of government bonds or Treasury Bills (T-Bills), which are in theory a method of increasing or decreasing money supply , but are in practice utilized by the government to service its debt financing. The RBI can either sell T-Bills to mobilise resources so as to reduce the amount of disposable income people possess, or it could buy the T-Bills from the people during a deflationary period to increase the amount of money in circulation. The initial purchase of the T-Bills by the RBI from the Government are not considered as monetary or fiscal measures.

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  17. 7. When does the RBI hike and decrease the interest rates? What impact does it lay on the economy?
    RBI alters the interest rates to control the amount of money in the economy. Depending upon the state of the economy, it will either encourage the common man to spend more or save more.
    Impact of change (decrease) in interest rate:
    i) Due to decrease, loans become cheaper and purchasing power of people increases.
    ii) The producer gets a surplus demand in the market, and hence increases production.
    iii) It leads to need for more raw material, capital and labour. Hence, the sale of raw materials increases, along with more number of jobs in the economy.
    iv) Investment will also increase greatly since the demand in the market is high.
    The opposite will occur in case of increase in interest rate.

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  18. 5. In the present scenario of weak investment sentiment and poor credit offtake, it is vital for the investors to be presented with affordable credit so as to boost investment sentiment and to jump-start the economy. To this end, the RBI has over the past one year reduced the repo rate by 125 basis points, on the assumption that such rate cuts would also be transmitted to the final investor or borrower. However small savings instruments such public provident funds and savings certificates offer a high rate of return on investment, i.e. rates that are significantly higher than the prevailing interest rates such that the real interest received by investors (nominal interest rate -inflation ) is positive to the tune of around 3 percent. In contrast, banks and other depository institutions offer lower rates of return on deposits which may not cover the rate of inflation prevalent in the economy and may therefore lead to a negative real interest rate i.e. a negative return on the investment. As a result investors have a preference for small savings instruments and the demand for deposits is lower. In order to attract sufficient deposits the banks must necessarily offer higher rates on their deposits. A higher rate of interest to be paid by the bank to the depositors means that the lending rate must be higher so that the bank can cover its costs and make some profit. Higher lending rates act as a disincentive for investment as credit costs are too high , which will further dampen the investment sentiment and send the economy into a downward spiral.

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  19. ALIGNING SMALL SAVINGS RATE WITH MARKET RATES
    ear government bonds
    There is a significant gap between the rates paid on small saving instruments and bank deposit rates or the yield on 10 year government bonds.
    Such a gap incentivises people to put their money in the small savings instruments.
    While making it difficult for banks to reduce deposit rates and, in turn, lower lending rates.
    Low lending rates are much needed in the current investment - starved economic environment.
    High administered rates for small savings in relation to both market rates and CPI inflation - act as effective impediments in the transmission of the RBI monetary policy signals.
    overall gains to the economy from lower interest rates will far outweigh benefits to small savings deposit holders.
    SHYAMALA GOPINATH COMMITTEE had suggested fixing small savings rates based on "a positive spread of 25 basis points, vis-a-vis government securities of similar maturities.

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  21. 3. What is Sukanya Samriddhi Account Scheme (SSAS)? What are its features?
    Sukanya Samriddhi Account (literally Girl Child Prosperity Account) in a Government of India backed saving scheme targeted at the parents of girl children. The scheme encourages parents to build a fund for the future education and marriage expenses for their female child.
    The scheme was launched by Prime Minister Narendra Modi on 22 January 2015 as a part of the Beti Bachao, Beti Padhao campaign. The scheme currently provides an interest rate of 9.2% and tax benefits. The account can be opened at any India Post office or a branch of some authorised commercial banks.
    Features of Sukanya Samriddhi Account (SSA):
    1. Sukanya Samriddhi a/c (or Khata) can be opened on a girl child’s name by her natural (biological) parents or legal guardian.
    2. SSA can be opened in the name of a girl child from the birth of the girl child till she attains the age of ten years.
    3. A depositor may open and operate only one account in the name of same girl child under this scheme.
    4. Accounts in name of the girl child can be opened in post offices or in any branch of a commercial bank that is authorized by the Central Government to open an account under this scheme rules.
    5. The account may be opened with an initial deposit of one thousand rupees.
    6. If minimum (Rs.1000 pa) amount is not deposited, the account will be treated as an irregular account.
    7. The deposits in Sukanya Samruddhi scheme can be made in the form of Cash or Demand Draft or Cheque.
    8. The applicable rate of interest on SSA for the financial year 2014-2015 is 9.1%.
    9. Birth certificate of the girl child has to be produced.
    10. The operation of the account shall not be permitted beyond the date of the girl’s marriage.

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  22. 3. What is Sukanya Samriddhi Account Scheme (SSAS)? What are its features?
    Sukanya Samriddhi Account (literally Girl Child Prosperity Account) in a Government of India backed saving scheme targeted at the parents of girl children. The scheme encourages parents to build a fund for the future education and marriage expenses for their female child.
    The scheme was launched by Prime Minister Narendra Modi on 22 January 2015 as a part of the Beti Bachao, Beti Padhao campaign. The scheme currently provides an interest rate of 9.2% and tax benefits. The account can be opened at any India Post office or a branch of some authorised commercial banks.
    Features of Sukanya Samriddhi Account (SSA):
    1. Sukanya Samriddhi a/c (or Khata) can be opened on a girl child’s name by her natural (biological) parents or legal guardian.
    2. SSA can be opened in the name of a girl child from the birth of the girl child till she attains the age of ten years.
    3. A depositor may open and operate only one account in the name of same girl child under this scheme.
    4. Accounts in name of the girl child can be opened in post offices or in any branch of a commercial bank that is authorized by the Central Government to open an account under this scheme rules.
    5. The account may be opened with an initial deposit of one thousand rupees.
    6. If minimum (Rs.1000 pa) amount is not deposited, the account will be treated as an irregular account.
    7. The deposits in Sukanya Samruddhi scheme can be made in the form of Cash or Demand Draft or Cheque.
    8. The applicable rate of interest on SSA for the financial year 2014-2015 is 9.1%.
    9. Birth certificate of the girl child has to be produced.
    10. The operation of the account shall not be permitted beyond the date of the girl’s marriage.

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