EPF ripple effect unlikely on other rates / Dec 12, 2005 / DNA India

From Indiapensions

EPF ripple effect unlikely on other rates

Sanjay K Pillai & Vivek Kaul

MUMBAI: Days after the government finally mustered enough courage to bring down the EPF interest rate for 2005 from 9.5% to 8.5%, bankers think that interest rates on administered schemes like the post office savings schemes, national savings certificates, public provident fund, will not change in a hurry.

Banks typically compete with these schemes for long-term deposits and the fact that some of these schemes offer tax-free returns is an added incentive for investors, apart from higher interest rates.

"Most of the money that has been invested in these schemes belong to senior and middle class citizens. It is a sensitive issue. Ideally there should be no differential but it may not be possible to bring down these rates immediately," says Cherian Varghese, chairman and managing director, Union Bank of India.

The interest rate differential between a long term deposit of 5 years, in a bank and an administered scheme can be as much as 2%.

For example a bank like HDFC Bank offers depositors an interest of 6.25% on 5 year deposits, when compared to say investments in the Kisan Vikas Patra (KVP) which offers investors a compounded interest rate of 8.41%. In such cases clearly an investor would prefer to put his money in an instrument like KVP. This movement of money into these schemes impacts the ability of banks to raise deposits.

But according to an analyst, who has been tracking the EPF interest regime closely, the government may not want to push its luck with the Left parties after having just effected a cut in the EPF interest rates.

With Indians generally not being covered under effective and properly administered social security schemes, the majority of the Indian household savings get channelised into these administered savings schemes. So even though good economics might call for an interest rate cut, real politik might force decisions the other way.

Further, a spate of scams over the years has ensured that a majority of the Indian investors, have stayed away from the equity markets. So higher returns on the administered saving schemes provide an investor with some incentive for saving.

Small savings schemes are backed by the central government but the money received net of redemptions goes to the states. The states repay the Centre over a period of 25 years. These small savings schemes have a maturity mismatch when it comes to repayment obligations.

This has led to a situation wherein half of the new collections are used for redemption of the previous deposits which is not a good practice to follow.

Further the states have to pay a higher rate of interest on these loans than rates they would be charged if they raise money directly from the market. The states can raise money from the market only after they have exhausted their share of borrowings which comes to them from the money that is raised under the various small savings schemes.

Also a higher rate of interest on these schemes leads to households depositing more money with these schemes. This leads to misallocation of savings with lesser savings being available for private investment. So it makes economic sense to bring down the interest rates of the other schemes as well.

This is the economic side of the argument. But what makes economic sense usually does not make political or social sense.