Something I wrote on EPF about a year ago, when the drift from EEE to EET was apparent- Maybe NPS is the right move ahead, but given the low income base and the width of the base of India’s income pyramid, we need some assured return products. PF can be limited for salaries up to 20K or so per month, and employer contribution capped at that salary level.

 

Thursday, January 22, 2015

PROVIDENT FUND – A parallax view

 

Provident Fund has always been a source of irritant to the policy makers and the critics. To me, it is a question of too much thinking on a straight and simple topic. To me, the Provident Fund is the cornerstone for my retirement. I do not want any risks to be taken with it. While I understand the benefits of equity investments, I do not wish my PF to be put in to this instrument. I do not want my PF money to ever grace the bank account of any private sector company in India. My PF gets invested for long term and nothing except the sovereign guarantee will survive the tenure of a PF.

I am happy if the government guarantees a rate of around eight percent (assuming we do not see inflation cycles worse than what we have seen in the last thirty years). If required, the government can say that if the inflation rate is below eight percent per annum over a five year moving average, the interest rate would be eight and should it go up, it would be adjusted to match the inflation rate, for those years where the eight percent moving average is breached. And let the benchmark for inflation be the Consumer Price Index.

Further, let the PF be limited to salaries of up to Rs.20,000 or so per month. In case of higher salaries, let the option be given to the individual to make a choice.

There is a complicated method of investing this PF money by the EPFO. So many intermediaries, so much of risk and at the end of the day, the return is around eight to nine percent. Why have all this complex arrangements and heightened risk?

Let all the money go to the government. In any case the government is raising debt by issuing paper. Let the PF moneys get a guaranteed eight or nine percent. The government may, at worse be paying an extra percent or two over the long term. Today, the EPFO has nearly 42 million accounts. Let me assume, generously assume that the average PF per account (12% of 15,000 from employer and employee each, per month- or around Rs.3,600 per month, including employer contribution) is an annual Rs.43 thousand. So for 42 million accounts, the annual accretion would be of the order of under Rs.200,000 crore each year! Today, the PF amounts cited include the PF on the higher salaries too, without the ceiling cut off. Let the ceiling be in place- After all, the government is obliged only to provide a base level and not guarantee the savings of the rich and famous through subsidies. At under Rs.2  lakh crore today, even if this increases by five to six percent each year, the damage on the exchequer is not large.

On 2 lakh cr, the differential would be around Rs.4,000 crore for the year. Let us assume an accumulated corpus of 20 years. In which case it would be around Rs.20 lakh crores or so, with compounded interest. On this amount, annual subsidy at two percent would beRs.40,000 crore! And we can do away with all the management costs that are now being incurred in the management of the corpus. And this subsidy is well worth the social benefits that accrue. This 40,000 cr number assumes that the Govt can raise perpetual money at six percent. If we think eight percent is fair, then the question of subsidy does not arise at all.

So, instead of debating where to put the PF money etc, let the entire thing go to the govt, interest be funded each year by the govt and do away with private trusts or management of PF moneys.

( I hope my basic numbers are right. If anything, I have perhaps erred on the higher side, I think)

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