Time to bring provident funds in line with market rates / Dec 13, 2005

From Indiapensions

Time to bring provident funds in line with market rates

Minna Kumar

The decision by the Employees Provident Fund Organisation (EPFO) to cut its interest rate by one percentage point to 8.5 per cent is a welcome break for the organisation grappling with inadequate resources and antiquated book-keeping. It also brings EPF rates closer to market rates. If PPF and other contribution- based funds reduce their rates in line with market trends the government will have to look at long term fixed deposits as a retirement benefit, or contribution-based pensions that provide annuities.

The Employees Provident Fund Organisation (EPFO) has decided to cut the interest rate payable to its 40 million subscribers by 1 percentage point to 8.5 per cent for the current financial year against 9.5 per cent paid during the last three years. The reduction is aimed at bringing the EPF interest rates at par with market rates. The yield on the 10-year government paper is estimated at 7.1 per cent. A bulk of the EPF corpus is invested in government securities.

There are 2,000 exempted trusts, which manage funds for employees of corporates, organisations and public sector enterprises. Their corpus is about Rs 30,000 crore. While the yield on investment of this corpus is between 7.1 per cent and 8.5 per cent, the trusts were to give 9.5 per cent return to employees had there not been any downward revision of the EPF rate.

Many trusts have old investments in gilts, which provide yields of about 9 per cent. But in the falling interest rate regime, it was a tough task to offer high returns on employee contribution.

The decision to pay 8.5 per cent for the current year will require an additional Rs 366 crore that the EPF does not have. But this is much better than the existing rate-a continuation of the 9.5 per cent interest rate, would have led to a Rs 1,176 crore hole in the books.

Small savings and Provident Fund (SS&PF) rates are higher than warranted by general economic conditions. This has led to excess funds in SS&PF schemes, without adequate investment outlets. There is no other way to stem the small savings surplus, which is causing huge interest payouts for the government, than to cut the SS&PF rates, and more so, to abolish the various tax sops on these schemes.

For example, the current 8 per cent PPF rate may not seem unduly high in relation to market interest rates, but represents an exorbitant return due to tax relief, and needs to be lowered further.

If the government were to offer the option of long-term fixed rate deposits, then it would be in a position to control the small savings surfeit with all its accompanying problems. It is time India has a policy that focused on ensuring professionally managed, defined contribution-based pensions that provide annuities, as in developed countries