Dhirendra Kumar
CEO
Value Research
Bargaining is a great art form in India, and the Left and the trade unions practice it expertly.
At a point when the only rational direction for Employees Provident Fund (EPF) interest rates can be downwards, they are clamouring for it to be hiked to 12 per cent.
Eventually, I suppose, they'll "compromise" and agree to a 9.5 per cent rate of interest.
This is an admirable political strategy "" to make an uneconomic 9.5 per cent payout appear to be a concession.
So far, there have broadly been two sides to the debate on the rate of return that the EPF should offer. The red flag contingent wants 12 per cent, and will probably settle for 9.5 per cent or so. The market-linked contingent quotes 5.5 per cent as the market-linked rate of return as the goal towards which the EPF should work.
There are two ways to calculate the value of fixed-interest investments of the kind this money is invested in. One of them involves marking the value of the investment to its present market value, and then calculating the return as a percentage of this.
The other way simply fixes the value at the original face-value of the debt and takes the return as whatever rate of interest it is earning. The EPF Organisation (EPFO) uses the second method and there is nothing much wrong with it "" it is a more conservative way of doing things, which is appropriate for an investor who is going to hold investments until they mature.
The correct way forward is to link EPF returns to the actual investment performance of the monies that are being managed under this scheme. The fresh government debt is being issued at 5.5 per cent or thereabouts.
The EPFO holds a great deal of older debt that earns it a much higher interest. There have been reports suggesting that the EPFO's shortfall "" the gap between what it earns as income on its investments and what its liabilities are at 9.5 per cent "" is a mere Rs 271 crore this year.
If this is correct, a rough calculation shows that the EPFO must have earned around 9.3 per cent or so this year (my extrapolation from last year's data indicates that there must be around Rs 1,40,000 crore in the EPF currently).
The kind of investments that are permitted under the EPF are extremely conservative, especially if they are to be held to maturity. Government and government-backed securities of one kind or another must be at least 90 per cent, with just an optional 10 per cent for private sector securities. Getting 9.3 per cent out of such a portfolio in this time is not bad at all.
The right way forward would be for the EPF return to be fixed for the year at the precise percentage that it has earned as investment returns in that year.
As the years go by and the EPFO's old, high-interest securities retire, this percentage would go down, which is the way it should be. And if, as is being suggested, the EPFO should try to earn more by better investment management, the benefit should show up in this return, too. In effect, the EPFO must be run like a transparent investment fund.
But, of course, not all political compulsions can be wished away, least of all by a government run by a party with a mere 145 seats in the Lok Sabha.
Therefore, even if the government decides to pay a higher, uneconomic return, it must account for it and explicitly transfer this subsidy to the EPFO every year. Whether the shortfall is Rs 271 crore or Rs 2,710 crore, it must not fall into the temptation of acting like a fly-by-night chit fund and start paying out present liabilities out of future funds.
Of course, such a subsidy may end up doing the same thing indirectly. But if the exact economic cost of an EPFO subsidy explicitly appears in every year's Budget, at least the likelihood of it growing into a huge black hole would be low. If it has to be quantified and transferred to the EPFO every year, then this subsidy has a fighting chance of staying at a size that can actually be managed, or perhaps, eliminated completely at some point.
Therefore, the government must not assume a round figure as the interest to be paid, but actually link it to real investment performance. And if that is 9.318 per cent or some such figure, so be it.
V Krishnamurthy
CEO
JM Mutual Fund
Specialists sometimes have a myopic worldview. Their insistence that administered interest rates for government-controlled savings instruments need to be reduced is one such instance.
Of course today, with the rising inflation, the weakening of the rupee against the dollar, and the increase on interest rates in Europe and the US, this debate may be academic; it is expected that interest rates in India would rise, too, in the near term.
On the other hand, the burgeoning fiscal deficit requires interest rates to remain low and it is expected that the Indian government would endeavour to keep it so.
Yet, there are two key reasons for insisting that Employees Provident Fund (EPF) continues to pay a higher-than-market rate of interest.
First, India does not have a social security system and with the change in demographics and the breakdown of the close-knit Indian family, the mutual support system that used to provide a sort of substitute has also all but disappeared.
A typical white-collar worker who retires or is superannuated otherwise, is completely dependent on the earnings from his provident fund (barring government servants who have inflation-linked pensions) to maintain a modicum of a middle-class lifestyle.
Even government servants (and their dependents) have a tough time wending their way through our relentlessly-corrupt system to get their dues. Add to this the increasing pressure to imitate the West and base corporate turnarounds on downsizing and voluntary retirement schemes (VRS), and we have a huge social problem on our hands.
The EPF is, thus, the sole bulwark for this growing population, between genteel poverty and abject poverty. It is our responsibility, in the absence of such basics as health maintenance organisations, social security, state-run old people's homes and so on, that we provide a respectable post-employment life for the middle-class.
Second, the EPF is currently a net one-way flow. Huge amounts of money compulsorily flow in and, since the population of the young in the country is growing at much faster rate than that of the old, an EPF with a higher rate of interest, can be self sustaining.
Of course, this is not a sound argument unless we use this time to build facilities that are taken for granted. A deceleration in population growth with improving education will accelerate the process of social improvement, and I believe that even our worst states will slowly move towards better standards in this area.
The question is what can be done in the meanwhile to compensate for this damage to our fiscal deficit. Some measures are fairly simple; others may require a little work.
Consider the usual suspects "" provident fund, people's provident fund, 6.25 per cent reserve Bank of India (RBI) tax free bonds, the US-64 bonds and post office savings. One can invest hundreds of crores in them either directly, or by taking advantage of the systemic inefficiencies, which make identification of unique individuals difficult.
The first step would be to cap investments in such subsidised avenues to, say, Rs 50 lakh, with some system for increasing the amount based on inflation.
Beyond that, investments should be allowed only in 401k-like investments, that is, directed investments by the employer into the equity market through systematic investment plans of mutual funds or equity-linked annuity plans of insurance companies.
Second, to ensure that the current abuse of the system is curbed, cash investments in these government subsidies avenues should be disallowed.
Further, investments by non-tax assessees (that is, pseudo-investments in the name of children and spouses), and investments by individual assessees with incomes of over, say, Rs 2 crore a year, should be disallowed, too. This would ensure that these avenues were used by those who needed them the most.
These investment avenues must also be barred for those who cannot disclose their permanent account number (PAN) number (including those who are in the applied-for category). Computerisation in post office savings and a unique identification number have to be implemented over a five-year period.
In the interim, while we wait for the systems to be put in place, perhaps a quick refund of investments over Rs 50 lakh in any of these avenues, to all those who don't have a PAN number, should be initiated forthwith.
In the interest of fiscal deficit it is perhaps worthwhile to make a start at a level that can take the hit, rather than affecting a huge population of people who have little alternative.
