Subsidy on icecream, anyone?

Indian Express, 9 December 2005

The EPF interest rate setting drama is distracting. Focus on the real crises

Did you receive an annual statement of balance for your provident fund with the EPFO on September 30? If not, you should worry. The records for as many as 85 per cent of accounts with the EPFO have apparently not been maintained properly. Yours could be one of them. If you have not received your statement, rush to your EPFO branch with your account number and ask for it. It is obligatory for the EPFO to give you such a statement on demand. It will do little good to know that you are going to get 8.5 per cent interest rate if there are no records for your balance.

Instead of focussing on the fundamental tasks of sound administration and sound recordkeeping, every time there is a board meeting, trade unions myopically squabble for higher interest rates. There is a profound lack of clarity that the interest rate is made on a market, and that trade unions demanding higher interest rates from the government is as silly as asking the government to provide cheaper ice-cream.

The EPF interest rate setting is an annual soap opera. It is a consequence of two constraints. On the one hand, the amount that is paid as interest has to be mutually agreed upon by the Central government and the Central Board of Trustees. On the other hand, under the EPF rules Para 60(4), the interest liability cannot exceed the income earned by the EPF from its investments during that year. Since EPFO assets are significantly deployed in the Special Deposit Scheme, in government bonds and other approved securities, this defines what interest rates can be paid. The notion that rates be set at the beginning of the year adds to the difficulty. At that time, there is only a projection of what the earnings might be. If EPFO were soundly run, the returns would be known at any time, the way your bank balance or equity portfolio is.

The EPF rate for 2005-06, set at 8.5 per cent, is a compromise between the 8 per cent rate recommended by the Board’s Finance and Investment Committee and the 9.5 per cent demanded by the trade unions. This decision comes out of tawdry politics, and not sound economics. Even though the EPFO’s income will be able to support only 8 per cent, the labour minister, chairman of the EPFO board, took on the additional requirement of Rs 370 crore. Chandrashekhar Rao is reported to have said, “There will be no burden on the exchequer. The burden will be on the labour ministry.” Oh, really? The labour ministry has no independent source of income. Money “belonging” to the labour ministry is as much a part of the exchequer as any other.

EPFO has a new man in charge, A. Vishwanadhan, who has ample experience in EPFO. His challenge will be to take EPFO away from the muddle-headed 1950s thinking to the extent that is humanly possible.

A burning issue that the EPFO board has been ignoring is that the Employees Pension Scheme (EPS). The EPS is a “defined benefit” scheme, similar to the erstwhile civil servants pension scheme. Like the civil servants scheme, EPS is bankrupt. It is a financial crisis worse than UTI ever was. EPS has a gap of at least Rs 22,000 crore between its projected assets and liabilities. The scheme defines the contributions to be made, the assets in which the funds can be invested — government bonds — and the pension to be received. This leaves no room for flexibility. The projected gap indicates that the benefits exceed the amount earned on the contributions. Who is going to pay for this gap?

Not only is the hole extremely large, it is expanding every year, as the scheme sees new members join every year. As the number of beneficiaries increase, the gap increases. The scheme is not sustainable and unless something is done now, the EPFO will have to renege on its EPS obligations in the future, just as many European countries have reneged on their defined-benefit pension plans.

At present few members may think that that is a problem, they may think the government will surely step in to pay. But many a government, when faced with fiscal crises, has reneged on its pension obligations. Who can guarantee that the government in power after 25 years will keep the promises made by the government today? When governments in Italy and Sweden made pension promises who would have imagined that they would renege on their promises?

The Left unions are trying to block reform of the civil servants pension scheme. They want to hang on to a defined benefit scheme. But EPS is a living demonstration of their ideas in action. The EPS should serve as a warning about the consequences of translating the 1950s Left ideas into policy.

EPFO needs to solve the mess on its recordkeeping, and change the design of the EPS. Workers pay an enormous 25 per cent of their consolidated earnings to the EPFO. Every member must get a statement of balance just as she does from a bank or from a stock depository. The design of the EPS needs to be changed to remove the defined benefits.

Why does EPFO have such fundamental problems? When an agency like the EPFO behaves badly, this is not because of individuals. It is because of deeper problems in the legal foundations and mandate of the agency. EPFO is like the old DoT in mixing up policy-making, service provision and regulation.

In the longer term, sorting out EPFO is not enough. The EPFO covers only 4 per cent of India’s work force. The government must address the broader issue of old age security in the country. The pension reform for civil servants is in great peril, with the PFRDA bill under attack from the Left parties. The government already has an implicit pension debt for central and state government employees of Rs 17 trillion, or 55 per cent of GDP. As this grows, so does the probability of default. The need to create a country-wide sustainable old age system must be given top priority.

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