The Employees’ Provident Fund Organisation, or EPFO, has announced that the rate of interest on the workers’ savings that are deposited with it will be 15 basis points lower in 2016-17 than what it was in 2015-16. Instead of being 8.8 per cent, workers will earn a marginally lower rate of 8.65 per cent. This is a welcome move. It moves the EPFO interest rate closer to other interest rates prevailing in the market, such as for small savers’ loan schemes and the yields on government debt. In fact, economic logic would have decreed a far deeper cut. The rate on 10-year fixed deposits with the State Bank of India is currently 6.5 per cent — a difference of over 2 percentage points. The difference is actually more because while EPFO interest rate is tax-free; bank interest is not. So the post-tax difference is closer to 4 percentage points, which is hard to defend on any ground. The Public Provident Fund, or PPF, earns just over 8 per cent, and the Kisan Vikas Patra just below 8 per cent. Clearly, EPFO continues to be out of line with other saving mechanisms, a reflection of the continuing political power of EPFO investors.
That the government has nevertheless decided to provide support to the cutting of EPFO rates, however marginally, is praiseworthy. It must now stand its ground. In the past year, it chose to roll back many changes to the EPFO structure under pressure from various stakeholders. Some of them — not all — were essential changes. The impression provided by the rollbacks, however, was that rationalisation of the savings structure was not something the government was willing to spend political capital on. Hopefully, that impression will be dispelled over time. It is crucially important for the government to rationalise all administered savings rates, bringing them closer to market rates. If it does not do so, then the transmission of monetary policy will continue to suffer. Banks have in the past resisted pressure to drop rates, even if the Reserve Bank of India had reduced the policy rates, because they have been scared of losing customers to other savings instruments. As pointed out already, the gap between the EPFO rate and fixed deposit rates is quite substantial. This gap must be closed in time. Broad-based consultation is a must to build buy-in from various stakeholders, but the government must be firm on the destination of its policy.
Beyond this welcome decision, more opportunities for reform exist. In general, there is little justification for the continued subsidy to the relatively well-off and gainfully employed that EPFO represents. The government has many calls on its purse at a time when it has committed to a path of fiscal consolidation. Such subsidies, which are not targeted at the most vulnerable sections of Indians, should eventually cease to exist. In addition, a more sustainable savings mechanism for the majority of Indians should be created. Indeed, much effort has already been sunk into creating one such instrument: The National Pension System, or NPS, a defined-contribution savings scheme introduced in 2004. The NPS has suffered because EPFO provides additional tax benefits — something Finance Minister Arun Jaitley attempted to remedy in the last Budget but rolled back after an outcry. This attempt should be made again, and with greater determination this time.