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EPF: To cut or not

May 23, 2003

The crucial decision on interest rates for EPF is to be taken by the Central Board of Trustees of PFO (Employees Provident Fund Organisation), and nearly 24 m salaried Indians are likely to be affected by the decision taken by the board. Apart from financial considerations, politics plays a key role in setting these administered interest rates. This aspect is more prominent in the current scenario when general elections are scheduled next year. However, if one were to concentrate completely on the economics of the whole EPF issue, it seems to be in the best interest of the government to rationalise the EPF rate downward. This view has been echoed by the Finance and Investment Sub-committee of the EPFO. This committee has recommended that the EPF rate be set between 8%-9%. Previously, the government had been issuing high interest bearing bonds in order to finance the interest payment needs of the EPFO. However, these bonds were issued in a period of high interest rates and they were justified at that point of time.

Till now the shortfall in payments has been met to a certain extent from reserves the EPFO has built over the years. But as these reserves get depleted, the EPFO will have to turn to the government in order to fund their shortfall. The shortfall scenario comes into being if the EPF rates are maintained at these levels. Any reliance on the government for funding is likely to put pressure on the fiscal deficit of the government. Simple logic dictates that while the government is paying an interest of between 6%-7% on its market borrowings, how can the EPFO be in a position to pay an interest rate of 9.5%, which is the current EPF rate. At some point of time this disparity has to be corrected otherwise there will be pressure on the government finances going forward. A bailout by the government of the kind seen for various financial institutions may not be ruled out for the EPFO if this disparity continues.

Since interest rates have fallen significantly in the last 3-4 years, it is time that the EPF be linked to market interest rates. While this may be to the dismay of the salaried class, one must understand that such high level of EPF returns is not sustainable in the long run, especially in a soft interest rate scenario. A senior World Bank official has stated that while Indian reforms have come a long way in the last decade, there is still a long way to go. He especially stressed on the poor fiscal deficit situation of the country, apart from emphasizing on further economic reforms.

The message seems to be clear, the government has still got to undertake various economic reforms in order to channel more funds for the development of basic infrastructure in the country. A small step in this direction will be the rationalisation of the EPF rate. While this may be an unpopular decision in the short term, in the long run it is the general populace that will benefit from economic reforms.

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