The Hindu Business Line : Salaried middle-class — Provident Fund no longer a lifeguard?

EVEN as a decision on the interest rate on provident fund (PF) contribution is proving elusive (the decision has been postponed to August 9 after the PF trustees, at their July 20 meeting, could not arrive at a consensus) to millions of salaried middle-class, a more fundamental issue of how long PF will continue to play the role of their life-guard, is staring them in their face.

Already, the PF rate has been brought down in the past few years from 12 per cent to 9 per cent now (the 0.5 per cent additional interest sanctioned last year as a special gesture is yet to be endorsed by the government, which explains why the PF members have not been even given their last year's PF statement even four months have gone into the new year). There have been suggestions that the rate should be market-linked, reduced to 8 per cent or indexed to inflation.

Though in the Budget, the Finance Minister had set the rate for PPF, GPF and Special Deposit Scheme (SDS) at 8 per cent, he left it to the Employees Provident fund Organisation (EPFO) trustees to decide on the PF rate as it is not in his domain. But he gave little leeway to the EPFO trustees to offer any higher interest by not announcing any budgetary support to bridge the gap between what the EPFO realised from its investments and the outgo in case the interest rate is maintained at the current level or hiked.

As per media reports, there was even a suggestion to offer a differential rate of interest depending on the outstanding balance in the PF account deposit levels or to make the PF withdrawal subject to income-tax. It was subsequently reported that the idea of offering a differential interest rate has been dropped. It is not clear whether the suggestion was to tax only partial withdrawals before retirement of members or the accrued interest in the PF account.

It is not the interest paid on the PF deposits that is the main issue for consideration. Every year, close to Rs 25,000 crore accrues to the EPFO's kitty by way of contribution from the members; the total corpus is put at around Rs 1.30 lakh crore. This is not idle money, but that which the government uses for development projects and for people's welfare. It will not be right for the government to look at the issue of whether the government can access funds at a cheaper rate if it goes for market borrowing or from other international lending sources because, by using the money of its own people, it is helping them lead a dignified existence in their old age. People are putting their money in the PF account, many of them contributing more than the required 12 per cent, in the belief that the money is safe as PF is largely government-controlled. If that belief goes, it would be a great blow to the investors.

On the one hand, government complains of paucity of resources to take up infrastructure or welfare schemes. On the other, by closing the investment options open to the public, the government is only starving itself of funds or making inadequate allocations so that the progress of schemes is painfully slow. A typical case is the meagre funds allocated to railway projects every year. By the time the projects are completed, the cost would have overshot the estimates substantially. Which is prudent — raising resources, even if it comes at a cost, to complete projects in time so that cost escalation is avoided and the targeted group benefits, or implementing them slowly, suffering huge cost escalations and project delays?

A suggestion was made for a differential interest rate for the PF depending on the balance. The argument was that most members have a small balance and, hence, offering higher interest would benefit the relatively poorer sections covered under PF. But the basic reason for this argument appears to be that the real outgo would be meagre because of the negligible balance.

But this is akin to differentiating the members of the PF on a class basis and makes mockery of treating all members as equals. Will anyone suggest such a course to the banks — that they should offer different rates depending on the balance in the accounts of the depositors? Though banks offer a marginally higher interest on bulk deposits, it cannot be compared to that suggested in the case of PF.

The banks offer just about 4 per cent for the savings accounts while marginally higher interest for fixed deposits, which are far below the rate of inflation now. PF accounts run for decades and the maturity value reaches a respectable level so long as the member does not frequently dip into the PF kitty, because of the benefit of compounding — a concept which investment analysts regularly advocate to their clients — and due to disciplined investing. It is not as if all those who have run up a substantial PF corpus are rich or earn fat salaries. It may be due to various factors such as efficient household expenses management, awareness of the need to save for a dignified post-retirement life, and so on. Should such members be punished for their prudence?

If the government so wants, it can bring down the minimum compulsory contribution from the present 12 per cent to 10 per cent or 8 per cent so that the inflow is lower or even put a cap on contribution.

According to a news report, while nearly 85 per cent of PF members have balance up to Rs 20,000, they constitute around 17 per cent of the EPF corpus. Members with balance from Rs 20,000 to Rs 4 lakh constitute about 15 per cent of the membership, but their contribution accounts for about 75 per cent of the corpus. Those with Rs 4 lakh to Rs 8 lakh balance account for just about 8.8 per cent of the corpus. In terms of numbers, those with a balance up to Rs 4 lakh form nearly 99 per cent of 30 million members and those with more than that form a miniscule percentage of the total.

It is clear from these figures that a higher interest rate benefits more people in the lower rung than the affluent, as it is made out to be, unless one says that anyone having a balance of a few lakh of rupees in the PF account, after decades of toil, should be classified as super rich. The benefit, if any, for the higher income (Rs 4-8 lakh balance holders) is not so substantial of the total outgo for EPFO to be a drain since their total share of the PF corpus is less than 10 per cent.

Why should the government, then, offer a scheme for senior citizens giving 9 per cent taxable return with an investment cap of Rs 15 lakh? To most PF members, accumulating that amount would be a dream even if they save throughout their career. And, when they retire, most members are either 58 or 60, nearly or actually qualifying for the latest scheme for senior citizens offering 9 per cent taxable return.

Any view that the PF interest rate serves as a benchmark for other financial institutions to fix their rates and banks would be hard-pressed to match it, leading to diversion of deposits, is incorrect, because while PF is a single product with a long gestation period, banks offer an array of instruments with varying maturities and PF members do not put all their savings into PF because of the interest difference.

PF is not an issue of a class war between the unorganised and the organised sectors. There was even an argument as to why PF should be given such importance when the unorganised sector does not have a similar benefit. There are other investment options such as PPF or NSC that are open to every citizen. There are many in the unorganised sector who earn much more than the PF members, but this is rarely mentioned and many such people are rarely taxed, unlike the salaried PF members.

The entire argument on the interest rate on PF deposits seems to have cropped up at the wrong time when the inflation rate has begun to go up and the interest rates are hardening. With inflation crossing 6.5 per cent, the real rate of return on PF deposits is less than 3 per cent and it is anyone's guess as to whether it is a fair return.

There are expenses such as children's education and health care that are hardly factored in while calculating inflation that it scarcely seems to be a reliable benchmark of the actual cost of living (see Business Line, July 3, report on the `coal truth' behind the inflation figure being below 6 per cent).

Leave aside for a moment the perceived security that PF offer s.What is the big deal about the 8-9 per cent return that PF offers when, adjusted against inflation, it is a pittance? It is possible for an astute member to make greater return from other investments such as the mutual fund or stock market than what the PF offers today and, probably, the government also wants to encourage such an attitude, if the steps taken by the government on the capital market front, such as abolishing long-term capital gains tax or exempting dividend from taxation, are any indication. But the mutual fund industry is still maturing and the capital market suffers from frequent seizures. But once investors gain confidence in other options and appreciate the advantages of long-term investments in securities, the fancy for PF would diminish over a period. Till then, probably, the government will have to nurture the PF baby.

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