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Should EPF interest rates be lowered?

July 29, 2004

The interest rate on the Employees Provident Fund, which had remained at 12 per cent from April 1, 1989, to June 30, 2000, has been lowered in successive phases to 9.5 per cent. There is a big question mark over this now.

Clearly, for the EPF organisation (EPFO), 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.

The government had been considering the EPF and other social security funds as a potential source of securing additional funds for its fiscal management. Of the total investments (of Rs 1,28,036.70 crore -- Rs 1,280.36 billion -- as on March 31, 2004) of the EPF under its three schemes, 74.81 per cent (Rs 95,784.15 crore -- Rs 957.84 billion) 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 the government kitty the bulk of accretions to the EPF funds. Unlike other investments, the EPF investments do not offer ready liquidity, as the EPFO had been directed to hold till maturity all its investments.

The government wants to continue to have the luxury of a captive source of funds in PF accretions and at the same time, it 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 consumer price inflation is accelerating and the wholesale price based inflation rate is zooming to 5.5 per cent, questions that need to be answered are: what should that real rate of interest be and can just 8 per cent be considered the rate for what are almost non-terminable deposits?

There are suggestions to free the PF and other small saving schemes from the "clutches" of the administered interest rate regime of the government and allow market forces to prevail instead.

Further, there is a clamour for a soft interest rate regime advocated by the industrial houses and players in the financial markets. Yet another poser made is that if the salaried class seeks more return, let it try its luck by opting to invest in the share market.

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 administered rate of interest has been brought down from over 13 per cent to 8 per cent in the past; the bank rate has been lowered from 10 per cent to 6 per cent over the reforms period; yet the prime lending rates (introduced in 1994) for five major banks still remains at 10.25 to 11 per cent.

In his annual policy statement for 2004-05, the governor of the Reserve Bank of India noted: "While there is intense competition among banks to lend to large, top-rated borrowers, other borrowers with long-standing relationships with banks and good credit record do not get the benefit of lower rates"(Para 78).

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 does not get 6 per cent even on a five-year term deposit, he is required to cough up nearly 13 per cent interest for an educational loan.

The NDA government was mulling the implementation of the Reddy Committee recommendation to benchmark the interest rate on EPF to the secondary market rates on government securities.

It is not known if the recent report submitted to the present finance minister by the committee headed by Rakesh Mohan, RBI deputy governor, has revisited this recommendation.

Otherwise, the benchmarking suggested by the Reddy Committee can lead to the rate plummeting to below 7 per cent even for 2004-05.

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.

The point forgotten is that the top borrowers and households operating in the capital market games are 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" precisely because they do not want the EPF to end the same way as the US-64 or the UTI.

The administered rates of interest on social security and small savings investments should be treated as social security expenditure by the government.

That is the only way to safeguard the interests of those who forego current conspicuous consumption and place their monies at the disposal of the government to be deployed for long-term economic development measures.

If the government does not want this EPF interest rate burden, the RBI should 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 remaining actively involved in such a mechanism.

The writer is secretary, Centre of Indian Trade Unions.

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