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Suresh Krishnamurthy

In its quest to reduce interest costs, the Government seems prepared to go any length. Scrapping PPF now appears to be on the agenda. There are, however, better ways to reduce its burden rather than jettisoning an instrument that has served society well.

THE Public Provident Fund may become a relic of the past if news reports are to be believed. A fait accompli may be presented to investors, with the argument that with pension funds soon to be in vogue, PPF will not be needed. However, it is difficult to see any link between pension funds and the PPF.

Prima facie, it only appears to be an attempt to cut the Government's interest costs. However, in pursuit of reducing interest costs, scrapping PPF does not appear to be justified. Investors, on their part, need to exercise vigilance if they are to save the PPF. Preserving the PPF is essential as it is effective in building wealth and is difficult to replicate.

Decades of service: PPF has been in service since 1968. For a substantial period since existence, it has been offering double-digit tax-free returns. Indeed, it is true that the high returns offered by the instrument are responsible for the shine associated with PPF. However, the instrument has proved effective not only because of the high returns.

It is mainly because PPF is the only long-term instrument available to investors that fully exploits the benefit of compounding. Importantly, there is no adverse fluctuation in year-end values of wealth. These two factors make it an effective instrument for retail investors.

It is true that reducing interest rates on PPF has proved to be a problem. The PPF is now offering a tax-free rate of 8 per cent when the tax-free market rate of interest is near 4 per cent. Cutting the interest rate is a politically sensitive decision and the Government has to tread cautiously.

Still, these issues do not justify jettisoning an instrument that is well understood by investors. The Government should attempt to reduce the yield on the instrument if it is proving burdensome.

Complements pensions: The argument being put forward is that in an era of pension funds, PPF will not be needed. Nothing could be farther from the truth. First, a pension fund is created out of the contribution of employees from their salaries. It is a compulsory retirement saving plan.

In contrast, investments in PPF are made out of the surplus remaining after consumption. In other words, PPF is complementary to a pension fund.

In fact, the PPF is complementary to pension funds in many ways. First, the wealth values of a pension fund fluctuate every year as the returns are linked to the market. In this context, a long-term investment option such as PPF whose wealth values will not fluctuate will protect investors from the truancy of market forces.

Second, pension funds do not have a 100 per cent debt option. However, investors beyond the age of 45 will need a 100 per cent debt option. At that age, being fully exposed to fluctuating equity values does not appear advisable.

PPF comes in handy then and a portion of the pension fund wealth can be transferred to it. The PPF can possibly be introduced as another option under the umbrella of pension funds.

Need for fixed returns: Guaranteed returns are an anachronism in an era where the returns of every instrument are linked to market. However, not all guaranteed returns are bad.

Guaranteed returns, especially returns that, even if low, go to build retirement wealth, are not bad. The Government did not feel the need for such instruments when it introduced Varishtha Bima Yojana. Now, to scrap the PPF goes against such a policy.

Importantly, PPF, with the maximum annual contribution restricted to Rs 60,000, is designed to help the relatively weaker sections of the society. PPF is designed as a provident fund for workers and the self-employed in the unorganised sector.

Guaranteed returns to such persons are very important. And exposing this section to the vagaries of market forces is highly risky.

If the budgetary resources needed to keep the PPF alive are proving burdensome, the Government must think in terms of reducing the returns sharply. It could also consider making the withdrawals from PPF taxable. Or, it could raise the age of entry into PPF to 45. In other words, the Government has many ways to reduce its burden. Scrapping the PPF is not the answer.

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