Retirement funds turn attractive in 2010

Often criticised for offering less attractive interest rates than banks for most of the last five years, retirement fund manager EPFO hiked the annual rate of returns on employee provident funds to 9.5 per cent in 2010 and this time around, the banks were left behind.

Although the rate hike may be difficult to maintain in the years ahead given the financial position of the organisation, the decision of the Central Board of Trustees (CBT), the highest decision-making body of the Employees' Provident Fund Organisation (EPFO), will benefit its over 4.71 crore existing subscribers in 2010, at least.

The EPFO had been offering 8.5 per cent interest on provident fund deposits for five years since 2005-06. The low rate of interest under employees provident fund schemes vis-à-vis the attractive returns that could be garnered through other investment avenues was not on account of poor investment decisions by the fund managers, but because of surplus funds lying unutilised in their coffers.

As per official income and expenditure estimates, it has been projected that a surplus Rs 6.4 crore (Rs 64 million) would accrue to the fund if the 8.5 per cent interest rate was maintained. However, there would be a deficit of Rs 291.08 crore (Rs 2.9 billion) if the rate of return was hiked to 8.75 per cent.

However, given that there was a surplus of Rs 1,731 crore in the interest suspense account of the EPFO, the decision to reward pension fund subscribers was meretricious. "We have decided to give 9.5 per cent rate of interest to subscribers during the current financial year on their contributions. For over four crore subscribers, this is a big gift from EPFO Trustees," Labour Minister Mallikarjun Kharge had told reporters after the meeting of the Trustees.

The decision, bankers feared, could see diversion of savings toward provident funds, as the difference between fixed deposit rates and PF rates would encourage people to park their funds in the latter.

At present, banks across the country offer a maximum interest rate of 8.75 per cent on fixed deposits. The EPFO's decision raised the eyebrows of bankers and the industry as a whole.

Higher rates of interest under EPF scheme would motivate people to lock away their savings in EPF schemes, putting a squeeze on liquidity. At present, employees can deposit 100 per cent of his basic pay in his PF account every month.

With this kind of interest rate, a working couple can choose to deposit either of their basic pay in a PF account.
Furthermore, people with multiple sources of income can also deposit their entire basic pay to earn higher tax-free returns.

The decision evoked adverse comments from industry chambers, which feared that the move would put pressure on interest rates.

Industry chamber Ficci said this could put pressure on interest rates of competing saving instruments and would have negative implications for government finances. Another industry body, Assocham, said the high rate of interest would not be sustainable either by the EPFO or by any other exempted trust on the basis of the investment pattern decided by the government.

"It is doubtful that this high rate of interest could be sustained," it had said. Meanwhile, putting at rest the controversy over investment of retirement funds in capital markets, the EPFO Trustees also made it clear that they would not invest in the stock markets and said they would continue to follow the existing investment pattern.

"We had received a letter from the Finance Ministry asking for parking of a portion of EPFO funds in the stock market. We have received huge opposition from the CBT members, who oppose the idea of investing in stock markets," Kharge had said.

Later, Labour Secretary P C Chaturvedi made it clear in a letter to Finance Secretary Ashok Chawla that the EPFO would not invest in stocks. The EPFO maintains a huge corpus of over Rs 3,00,000 crore (Rs 3 trillion), whereas all recognised PFs managed by it have accumulated funds to the tune of Rs 2,00,000 crore.

The decision to invest a fraction of over Rs 5,00,000 in the stock market could have made a big impact on returns, but such a decision carries it own risk, given the volatile nature of equities.

With regard to inoperative EPF accounts, the government had announced that the board has decided no interest will be credited in such accounts with effect from April 1, 2011. At present, around Rs 10,000 crore (Rs 100 billion) of unclaimed money is lying in more than 2.9 crore (Rs 29 million) inoperative accounts of the EPFO.

About 1.05 crore inoperative accounts, which constitute 34.58 per cent of all such subscribers, hold less than Rs 500.

All those accounts that have not been subscribed to for three years are treated as inoperative accounts. The EPFO spends about Rs 50 crore (Rs 500 million) on maintaining these accounts.