Provident funds and prudence

It should come as no surprise to the Government that the privately-managed provident fund trusts are unable to pay the same rate of interest on accumulated balances as the Government-managed provident fund scheme for employees in the private sector. The yield rates on gilts are at least a percentage point lower than 9.5 per cent — the matching rate that privately-managed trusts are required to provide. The fund administered by the Government at least had the advantage of credit balances available with it, though it is far from certain if these are actually surpluses. But privately-managed funds that do not boast of a sufficiently long history of operations have no such luxury. In the event, it would require financial alchemy of the highest order to generate additional surplus from an active churning of investment portfolio.

The Government is understandably keen that employees in the organised sector earn a positive real rate of return on their long-term savings. But there are structural rigidities in the system that come in the way of such an outcome. With investment flows increasingly getting globalised, interest rates in the Indian economy cannot be impervious to the effects of excess global liquidity. With monetary authorities in the West resorting to ‘quantitative easing' — an euphemism for pumping money into the system — some of it is bound to end up in emerging economies such as India. Interest rates are more likely to drift down than up. At the same time, the hardening trend of global commodities, particularly that of crude oil, and a rise in the prices in select pockets from an economy that is growing in excess of 8 per cent means that India would find it difficult to contain inflation. The day, therefore, is not far when even the government-administered provident fund would have to limit the interest rate that it pays to the returns earned by its portfolio. That being the case, forcing employers to make good the deficit is a hidden form of taxation and would only drive them to hand over the corpus for management by the Government. That would not be in the interest of employees in the private sector.

In the long run, the Government is better off dismantling its asset management business and asking employers to place employee accumulations with third-party fund managers. The existing apparatus for the provident fund should re-engineer itself as a regulatory authority responsible for oversight of private trusts rather than act as a fund manager.