EPF options

The rate payable on the Employees' Provident Fund (EPF) has been a bone of contention ever since interest rates started falling and the high administered rates paid during the 1980s became unviable.

While other administered rates have been steadily brought down, the rate payable on the EPF has remained at 9.5 per cent per annum, thanks entirely to the political clout exerted by the unions.

With the bulk of the corpus invested in the government's Special Deposit Scheme (SDS), which earns only 8 per cent, it's obvious that a payout at 9.5 per cent this year will leave a big hole "" a hole estimated by the EPFO at around Rs 927 crore this fiscal.

The stand taken by the Left, that a higher rate of interest is warranted as a measure of social security, needs to be taken with a large dose of salt since the scheme applies only to organised labour. And even within organised labour, the real benefits will flow to the creamy layer, with the top 15 per cent of accounts holding 85 per cent of the assets. There is no point subsidising only the top end of the salary earning class.

Small wonder, therefore, that sane voices have time and again called for administered interest rates to be linked to the market, and for the abolition of the SDS.

Unfortunately, while the economic case for bringing down EPF rates is crystal clear, it is political realities that will determine the final figure. If the rate is indeed pegged at anything over 8.25 per cent, the government will have to make good the shortfall.

That may be all right with the government, but corporates who manage exempted funds will have no alternative but to bear the burden of the subsidy. By law the returns on exempted funds cannot be lower than that for non-exempt funds. Moreover, the SDS, in which most of the EPF money is parked, has no rationale when the government can mop up money from government securities at much lower rates.

Under the circumstances, the way forward is to look for ways to enhance returns on EPF investments. The first thing to do is obviously to remove the administrative hurdles to active fund management.

Allowing active management of the corpus by well-paid professionals is, therefore, a must. At the same time, since equities give better returns than debt over the long term, a small proportion, say up to 10 per cent of the corpus, should be allocated to the equity markets.

That will diversify the EPF portfolio, insulating it against the risk of putting all its money in debt instruments. At the same time, recognising the risks involved in equities, and to allow fund managers time to improve returns, equity investment could initially take the form of investing in index funds rather than in individual stocks.

And just in case the risks of investing in equity are perceived to be too high, the government could guarantee to make up the difference between the administered rate of interest and the return from the equities portfolio for the first three to five years.

Over the longer term one would expect the equity portfolio to offer returns higher than debt. Such a solution would be a win-win one for the markets, for government finances, as well as for employees.