Business Standard

Improvident fund

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Business Standard New Delhi
While the election code of conduct has been cited as a reason for not cutting the interest rates payable on the Employees Provident Fund (EPF) from the present 9.5 per cent, it's difficult to figure out the justification for invoking this code.
 
What needs to be done is to reduce the rate, and a reduction can hardly be seen as populist and therefore something that an outgoing government should be prevented from doing.
 
EPF rates are way too high, no matter what benchmark you use. They're 1.5-2 percentage points higher than those on most government securities like National Savings Certificates (NSCs) and post office deposits.
 
At 9.5 per cent, the real rate of interest is between 4 and 5 per cent today "" for the 1990s, the real rate of interest offered by the EPF was 2.6 per cent. So, if one was to revert to the 1990s average, the EPF interest rates should be under 8 per cent.
 
The Employees Provident Fund Organisation (EPFO) needs to address several other serious issues. In a period when most government securities are offering returns of 5-6 per cent, how can the EPF, which invests primarily in these, offer higher returns?
 
The EPF invested in bonds in the past which offered higher interest rates and the money's coming from there. The issue then is, have these bonds been marked to market?
 
IFCI bonds held by the EPF may be yielding a 14 per cent return, but since there is a huge default probability on these bonds, have they been accounted for at their face value or their market value? Unfortunately, few outside of the EPFO universe seem to know since the system of accounting is quite opaque.
 
Apart from the potential hole in the EPF scheme, the EPFO has a serious problem in the case of the Employees Pension Scheme (EPS) that it runs.
 
The EPS is what's called a defined benefit (DB) scheme, where each pensioner is guaranteed a certain pension after he retires, say, Rs 500 a month.
 
While the EPFO can service this pension with a capital of Rs 1 lakh, say, when the interest rates are 12 per cent, the same pension amount clearly cannot be serviced when the interest rates have halved.
 
But that's precisely the situation in which the EPS is in today "" it has committed certain benefits to pensioners, but doesn't have the capital to service this. This haemorrhaging needs to be stopped immediately.
 
The ideal situation would, of course, be to move from a defined benefit scheme to a defined contribution (DC) one "" in this case, employees contribute a defined amount, and the pension they get will depend on the kind of returns the EPS is able to generate from the money.
 
This, naturally, will be opposed by all beneficiaries, and will require tremendous political will to push through.
 
The other option is to at least limit the damage by not allowing any more new entrants into the EPS, in exactly the same manner that the government has done for the pension schemes run for bureaucrats.
 
When the new government comes in, it's most important task, apart from setting the new EPF interest rate, should be to fix the entire EPFO system.

 
 

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First Published: Mar 11 2004 | 12:00 AM IST

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