People's Democracy

(Weekly Organ of the Communist Party of India (Marxist)

Vol. XXVIII

No. 29

July 18, 2004

Soft Interest Regime &

Interest Rate On EPF: A Reality Check

 

W R Varada Rajan

 

THE meeting of the Central Board of Trustees (CBT) of the Employees Provident Fund (EPF) held on June 30, 2004 decided to defer its recommendation to the Government of India on the interest rate payable to the subscribers of EPF for the year 2004-05. This tripartite forum came to this unanimous conclusion, besides urging the government to continue the Special Deposits Scheme (SDS) for making fresh investment of EPF funds and also to clear the notifications in respect of the past two years viz. 2002-03 and 2003-04. The deferment was mainly in the context of the trade unions taking up with the government the issue of upward revision of the administered rate of interest (on small savings, GPF, PPF, SDS etc.), keeping in view the demand for restoration of the rate of 12 per cent prevailing up to June 2000.

 

The media is now replete with stories terming the demand of the trade unions as ‘untenable’ and goading the government - particularly the finance minister - to ignore the plea for upward revision but rather effect a further downward revision of the EPF interest rate.

 

QUESTION MARK

 

The interest rates on the Employees Provident Fund (EPF), which had remained at a steady 12 per cent during the period from April 01, 1989 to June 30, 2000, have been lowered in successive phases to 9.5 per cent. There is a big question mark over this now.


Clearly, for the EPF organisation, it is a challenging task to balance the interest rate it offers to its subscribers and the yield it earns on the investment of its corpus.

 

Who is responsible for creating this imbalance?

 

The Government of India had been considering the EPF and other social security funds as a potential source of securing additional funds for its fiscal management. Out of the total investments (of Rs 1,28,036.70 crore as on 31.3.2004) of the EPF, under its three schemes, 74.81 per cent (Rs 95,784.15 crore) is lying with the government. These are mandated investments covered by the government decision on administered rates of interest. Even now, the government guidelines to the EPF on its investment pattern are aimed at securing in government kitty bulk of the accretions to the EPF funds. And unlike other investments in the banking system or the capital market, the EPF investments do not offer any kind of ready liquidity, as the EPFO had been directed to ‘Hold Till Maturity’ all its investments.

 

The problem is that the government wants to continue to have the luxury of a captive source of funds in PF accretions and at the same time seeks to deflate its interest burden. By seeking a higher rate of interest on EPF, the trade unions are not asking for any undue reward or favour; they only seek from the government an adequate real rate of return to the members of the salaried class for the compulsory impounding of their hard-earned savings. At a time when the consumer price inflation is accelerating, and even the wholesale price based inflation rate has zoomed to 5.5 per cent, what should be that real rate of interest and can a rate of mere 8 per cent be considered real rate for what are almost non-terminable deposits, are questions that beg answers.

 

In answering these questions, the international experience also needs to be kept in view. In the OECD countries as well as some of the developing countries, the fixed income funds under the provident funds and social security schemes, earn a real rate of return of over 4 to 4.5 per cent. Why then parry the question of ‘real’ rate of return on our soil?

 

 

‘SOFT’ FOR WHOM?

 

There are suggestions to free the provident funds and other small saving schemes from the 'clutches' of administered interest rate regime of the government and allow market forces to prevail in the matter of interest rates. Further there is a loud clamour for a soft interest rate regime advocated by the industrial houses and players in the financial markets. Yet another poser made is, if the salaried class seeks more return let it try its
luck by opting to invest in the share market.

 

The government accepted this clamour for soft interest rate regime and had been resorting to interest rate reduction on all fronts. The administered rate of interest had been brought down from 13 per cent plus to 8 per cent over the recent years; the bank rate had been lowered from 11 per cent to 6 per cent over the reforms period (lowest since 1973). To facilitate free flow of bank credit, the liquidity position of the banks were sought to be improved by lowering the quantum of mandated investments by the banks viz. the statutory liquidity ratio (SLR) and cash reserve ratio (CRR); the SLR had been reduced to 25 per cent from a peak of 41 per cent in the late 80s and the CRR to 4.50 per cent from 15.00 per cent in 1990-91.  Yet the Prime Lending Rate, which was 12.00 – 12.50 in 1999-2000, had only come down to 10.25 - 11.00 per cent. (RBI Bulletin, June 2004)

 

But, the questions remain: “Who is the beneficiary of the much lauded 'soft interest rate regime? Has this soft interest regime benefited the economy as a whole? Has it resulted in further investment? Has it increased employment opportunities?” The advocates of soft interest regime are yet to come out with any substantive answers to these questions. 

 

On the other hand there are stark evidences to establish that the ‘soft’ interest regime had been beneficial to only a select few.

 

Emphasising the need to ‘understand the politics underlying interest rates’, A V Vedpuriswar, Dean, ICFAI Business School, Hyderabad, had candidly put: “Two powerful constituencies are the main beneficiaries of lower interest rates – large corporates and the government.” The government had been unable to cope with the interest costs recording a 400 per cent increase between 1990-91 and 2000 -01. This has weighed with the government to resort to reduction in the rate of interest, which has made government the real beneficiary.

 

Despite efforts to help the banks to have more liquidity to accelerate their lending operations, the banking system holds government securities to the extent of 41.5 per cent of its net demand and time liabilities (NDTL), as against the statutory minimum requirement of 25 per cent. In terms of volume, such holdings above the statutory liquidity ratio (SLR) amounted to Rs 2,69,777 crore which is much higher than the annual gross borrowings of the government. (Annual Policy Statement for 2004-05 by the Governor of the Reserve Bank of India – Para 22)

 

In the same statement the RBI Governor notes "While there is intense competition among banks to lend to large top-rated borrowers, other borrowers with long standing relationship with banks and good credit record do not get the benefit of lower rates"(Para 78).

 

The other aspects manifest in the way our banking system is functioning, is also worrisome. Some of these have been noted in the Economic Surveys of 2002-03 and 2003-04 as under:

 Further, the players in the financial markets luring the middle-income groups with credit card offers, charge almost 24 per cent, plus the annual fees, penalties and other charges. While an individual banking public does not get a 6 per cent rate even on a five-year term deposit, he is required to cough up nearly 13 per cent interest for an educational loan for his ward!

 

A Reserve Bank study on the performance of private corporate business sector for the year 2002-03, which covered 1,267 non-financial non-government public limited companies, revealed that interest payments declined by 11.7 per cent from Rs 16,726 crore in 2001-02 to Rs14,765 crore. Even in this, 76 companies with the paid up capital of less than Rs 1 crore had a higher incidence of interest burden by 1.3 per cent, while those with Rs 25 crore and above (190 companies) had benefited with the decline in interest burden by 13.1 per cent.   (RBI Bulletin - October 2003) 

 

It is, therefore clearly evident that the interest rate regime had been ‘soft’ only on the creamy layer of borrowers in the banking system, and getting much harder on small-scale industries, farmers and households. In this backdrop, the trade unions cannot be faulted in rejecting the concept that social security funds also should be subservient to this 'soft interest regime'.

 

DIFFERNTIATE SOCIAL SECURITY FUNDS

 

The banking system raises its finances through term deposits ranging from seven days to five years. The social security funds are not deposits of any fixed tenure; for the government they are non-terminable funds. There has been no outflow from the Special Deposit Scheme commenced in June 1975 or from the public account into which funds have been poured since 1971, when the Family Pension Scheme commenced.

 

The Employees Provident Fund is a social security scheme. The accumulations in the EPF are not comparable with any of the other deposits or investments, either in the banking system or even the saving schemes operated by the government. While the latter have a pre-determined periodicity and a definite date of maturity, the EPF accumulations are almost a life time deposit, spanning the entire work life of over 30 years, from the individual subscriber to the EPF. But, the government holds these accumulations for still longer period and in the case of Special Deposit Scheme, there has been no outflow, ever since the scheme was launched during 1975, nor is likely to be in future. While the depositors in banks and the government schemes for small savers have the option to move freely across the different avenues open to them, the EPF subscriber has no such freedom to decide on where to place his money. The EPF accumulations are a mandated savings and offer no scope for premature withdrawals or for use as a cover to obtain even a short-term loan. Hence, the interest payable on EPF bears no comparison with the other time liabilities of either the banking system or the government.

 

The Government of India introduced the Special Deposits Scheme (SDS) for non-government provident, superannuation and gratuity funds on June 30, 1975 with a 10 per cent rate of interest; at that time the EPF subscribers were getting only 6.5 to 7 per as interest. The government notification on SDS specified that it was “intended to enable the subscribers to these funds to get the benefit of higher interest rates on their subscription to these funds.” Thus, the Government of India move to reduce the rate of interest on SDS, as had been done successively since April 01, 2000, runs counter to this basic objective.

 

The government had been insisting that the interest rate on EPF should be ‘aligned’ with that of the GPF (of government servants), PPF, small savings etc.  Historically, these rates had never been ‘aligned’ before. Up to the year 1989-90 the interest rates on EPF was below that on GPF. The Government of India cannot as a matter of parity bring down the rate of interest on SDS equal to the interest on GPF. While the government servants are entitled to pension payments, with dearness relief, on a Pay As You Go (PAYG) basis from out of the Consolidated Fund of India, the EPF subscribers are granted pension at far less a rate, under the EPS, 1995, which is funded by diverting 8.33 per cent of the employers’ contribution to the EPF, without any dearness relief portion.

 

Therefore, it is essential that the administered rate of interest on social security and small savings investments should be treated as social security expenditure by the government. That is the only way the interests of those who forego current conspicuous consumption and place their moneys at the disposal of the government to be deployed for long term economic development of the country, are protected.

 

Hence it is necessary that the social security funds should be accorded a differential treatment in the sphere of interest rate and not forced to mechanically toe the banking system.

 

ATTITUDE OF UPA GOVT

 

The NDA government was mulling options to implement the Reddy Committee recommendation to benchmark the interest rate on EPF to the secondary market rates on government securities. The benchmarking suggested by Reddy Committee can lead to the rate plummeting to below 7 per cent even for 2004-05. Thus, the option is wide open to UPA government to alter the interest rate in either direction. It is not known if the recent report submitted by the Committee headed by Rakesh Mohan, deputy governor, RBI, to the present finance minister, has revisited this recommendation.

 

The CMP adopted by the UPA government had in this regard stated: “Interest rates will provide incentive both to investors and savers, particularly pensioners and senior citizens. The UPA government will never take decisions on the Employees' Provident Fund (EPF) without consultations and approval of the EPF board”.

 

The trade unions had presented their case for revising upwards the administered rate of interest from the present 8 per cent to both the finance minister (during his pre-budget consultations) and the prime minister, when he interacted with the trade union representatives on June 23, 2004. 

 

The finance ministry placed its view in writing before the CBT at its recent meeting that ‘the current interest rate (9.5 per cent) is clearly unsustainable’. The representative of the ministry who attended the meeting even insisted that the interest rate for 2002-03 should be reduced to 9 per cent and for 2003-04 to 8 per cent, even though the CBT had recommended an interest rate of 9.5 per cent for both the years. The statutory notice on the interest rate had not been issued for these two years till now. While the EPF Organisation (EPFO) had implemented the 9.5 per cent interest rate for 2002-03 through an administrative circular, the interest rate for 2003-04 had not been given effect to by the EPFO. Despite being clarified that as per the scheme provisions the government has only to ensure that there was no overdrawal on the interest suspense account by the EPFO, which is the case even if the rate as recommended by the CBT were implemented for these two years, the finance ministry was unwilling to clear the notifications for past two years as well.

 

Hence, the attitude of the UPA government towards this crucial issue will have to be judged on what its maiden budget offers. With the finance minister deciding to stay with the reduction of interest rate on GPF, PPF and Special Deposits Scheme effected by the NDA regime (at 8 per cent) it has become imperative for the trade unions to assertively pursue their demand in every possible way

 

WAY OUT


Much is being made of the tax-breaks allowed on EPF and small savings, as also the low percentage of the salaried class to the total population et al. But, the point conveniently forgotten is that the top-borrowers and households operating in the capital market games are just a few and the debate on this issue cannot be relegated only to serve their interests.

 

Finally, the trade unions are totally opposed to the suggested ‘stock option’ i.e. investment in share market, precisely because they do not want the EPF to end the same way as in the case of US64 of the UTI.

 

If the government does not want this EPF interest rate burden to punch holes in its fiscal management, a simple way will be to entrust the RBI to administer these funds, as it does in respect of the Special Deposit Scheme, and evolve a transparent mechanism to decide an inflation-indexed real rate of return to the salaried class and saving community, with the trade unions kept in picture in evolving as well as monitoring such mechanism.

 

The basis for determining such a real rate of return could be the annual GDP growth, hedged against inflation, as it can be safely assumed that the subscribers to the social security schemes can have a rightful claim to the same incremental value, as that of the economy, to their long term savings deployed for its development. Restoration of the 12 per cent interest rate, demanded by the trade unions, cannot be faulted, if such a reasonable norm is adopted.

 

This is not an impracticable suggestion.

 

The Reserve Bank of India operates is own scheme for administering the Provident Fund of RBI employees. Though the provisions of the RBI Act, 1934 stipulate that investment of these funds also should be as per direction of the government, the RBI had been maintaining these funds without any specific investment portfolio. The provident fund of the RBI staff is in a proforma account with the RBI itself and the funds are invested in day-to-day operation of RBI. Yield is calculated on the return that the RBI lendings fetch and when the EPF rate of interest was sealed at 12 per cent, the RBI was paying its staff an interest of 13.25 per cent up to 1997-98, without any tax deduction even beyond the 12 per cent limit prescribed by the Income Tax regulations. (The only difference was that the RBI was crediting interest calculated on half yearly balances, while the EPF credits the same on monthly running balances.)

 

When such is the case with the provident funds administered by the RBI, why the same RBI, with which the SDS amounts are deposited, should not be required to take care of the social security funds and work out a mechanism of inflation-indexed real rate of return?

 

Will the UPA government – and particularly its finance minister – care to give this a consideration?