Debate over whether the Public Provident Fund should be scrapped is on. Some say PPF distorts the broad-based debt market and market-related interest rate structure; others oppose is vehemently. Read on. . .
Amit Gopal, Vice President, India Life Capital:
It's Budget time again; that time of the year when the focus returns to interest rates on small savings instruments.
The past couple of years have seen a "rate war" on provident funds with employee unions and their ilk resisting moves to align interest rates on the Employees' Provident Fund to market rates.
The acrimony of this debate has taken away the focus from larger reform issues that need urgent attention, one being the need to reform various government-run small savings schemes and the Public Provident Fund.
Why reform the PPF? Because if it continues in its current form and structure, it will gradually work at cross purposes to its primary purposes -- of promoting growth while offering investors a secure structure of social security and long-term savings.
Let's look at the social security and savings angle, one that is touted as the case for retaining the PPF.
The PPF, in its current form -- fixed and administered interest rate, tax incentivised, and risk free -- belongs to an era when capital markets were neither developed nor easily accessible to retail investors, financial products across various risk profiles were not available, and financial literacy among investors was low.
The banking industry was not well dispersed and the outlook to investment products was largely risk-averse. Investors in both the unorganised and organised segments needed a financial instrument akin to the PPF.
India has clearly moved on since then. The past decade has seen a significant growth both in scale and access to the capital markets. The advent of the mutual fund industry and privatisation of insurance has meant an increase in financial products across risk profiles.
Across the country, intermediaries in the form of distributors, portfolio managers, individuals and banks vend products whose underlying assets are either fixed income or equity.
These intermediaries have, though not in the most efficient way, facilitated the process of financial literacy among investors. The absence of financial products is, therefore, no longer an excuse for retaining the PPF in its current form.
Intuitively, therefore, investors in the PPF are either interest rate and tax concession arbitrageurs, or are part of the unorganised sector.
One cannot quantify the former in the absence of empirical data on the quality of investors, but a parallel is evidenced in increased voluntary provident fund contributions to the EPF.
Has the PPF played its role of promoting growth ? It may have helped the government mobilise funds but the success story ends there. The costs have and will continue to outweigh the benefits.
Three costs stand out: the impact on the development of the debt market; the fiscal impact; and the inefficiency in allocation of resources.
The presence of the PPF (along with its other small savings cousins) as an investment alternative to individuals continues to distort the development of the broad-based debt market and a market-related interest rate structure.
The crowding-out effect is evident in the surge in mobilisation of the PPF and other small-savings products.
Why would a retail investor buy a long-term, fixed-income financial product or a long- to medium-term government security when the government is willing to pay him 2 per cent more on the PPF?
This brings us to the next adverse impact -- the fiscal one. The spurt in borrowings has resulted in increased high-cost liability. Contributing to the adverse fiscal impact are higher-than-market interest cost and loss of revenues on account of tax incentives.
The circularity created has meant that the PPF resembles a 'ponzi' scheme; one that is also a non-transparent way to fund fiscal deficits.
The PPF continues to shield the state government from fiscal distress. Rampant fiscal profligacy has made state governments the worst offenders among large borrowers.
Yet, with increased allocation of mobilised amounts to state governments and the Central government virtually underwriting the debt, any form of investor-driven disciplining is unlikely. The PPF has clearly outlived its developmental purpose.
So should the government scrap the PPF tomorrow? To say yes is being insensitive to the needs of a large investor base, especially those in the unorganised sector, to whom the PPF represents the only social security apparatus.
A phased dismantling is preferred. This should coincide with the introduction of formal pension/ long-term savings products. This phase should renew focus on financial literacy for the hitherto PPF-dependant investor.
It would also be useful, in the interim, to evolve structures that eliminate the use of PPF interest and tax arbitrages.
Implementing these reforms will take some gumption on part of policy implementers. For a government that has initiated similar steps to reform its own pension structure, initiating similar steps on small-savings products will be a matter of deciding not to play fixed-income fund manager to millions.'
As told to BS Bureau
M K Pandhe, President, CITU:
The constitution of the Pension Regulatory Authority by the United Progressive Alliance, by promulgating an ordinance is a hasty step taken without consulting trade unions in the country.
It is difficult to understand why the government did not bring a bill in the Parliament for an in-depth consideration of major social security measures as well as a major small-savings instrument, and resorted to promulgation of the Ordinance to make the decision fait accompli for the workers and the people.
This step, along with the decision to discontinue the Public Provident Fund (PPF) scheme, was earlier visualised by the National Democratic Alliance government. It is just another instance of the UPA government carrying forward the earlier government's policies.
The PPF scheme, as available to the general public, gives tax benefits to the depositors and offers a higher rate of interest than is available in the fixed deposits in banks.
Thus, it became one of the major saving instruments. People found it safer to deposit their money in PPF schemes since it gives a higher income to an individual after retirement.
Despite a reduction in the rate of interest in successive years, the PPF scheme continued to remain attractive for small savers seeking tax-rebates.
But for government employees joining service from January 1, 2004, the character of the pensionary benefit was changed to a contribution-defined scheme.
Besides being thoroughly uncertain of the amount owing to stock market-oriented investment planning, courtesy the Pension Fund Regulatory and Development Authority (PFRDA) Ordinance, it is destined to be reduced drastically.
In this background, to these employees the PPF scheme, in its existing form, could be the only instrument to rely upon to supplement their retirement benefit.
Unilateral discontinuance of the PPF scheme will, thus, affect those employees and small savers who constitute a substantial section of the populace.
Taking advantage of the government's policy patronage, a number of private pension fund agencies, including foreign agencies, are emerging or are in the process of entering the market.
They cannot ensure sustained returns and safety of savings simultaneously as in the case of the PPF in its existing form.
The experience of huge losses to workers who got their pension funds invested in the stock-market through foreign pension fund agencies in Japan, the US and some other European countries, have not been forgotten.
The same may be repeated in India where market is more vulnerable to manipulations.
Hence, the existence of the PPF scheme in its existing form is a veritable hurdle and a bottleneck to those emerging private pension/ mutual funds to flourish.
And thus the present government decides to discontinue the PPF to promote those stock market-oriented fund operators at the cost of the interests of the common people.
By discontinuing the PPF scheme, which entails long-term deposits by the people, the government will only restrict the availability of funds with a longer maturity period with it for development activities. Also, it will retard the role of the government as a social welfare state.
The private fund managers being patronised by the reforms-savvy government are coming to market not for public welfare, but solely for profits. They cannot be expected to play any role in the interest of the depositors.
The discontinuance of a welfare-oriented scheme like PPF so as to serve private fund managers' interests and divert small savings for the stock market, is thoroughly unwarranted and militates against the very spirit of the National Common Minimum Programme that promises welfare to the poor.
The PFRDA is designed and destined to ensure the interests of the private (and also foreign) fund managers and not the public-welfare schemes like the PPF or, for that matter, the interests of the depositors and the common people.
The track record of other regulatory authorities already in place in promoting private players at the cost of public sector and public agencies clearly indicates this reality for the PFRDA as well.
And it is not the PPF alone.
Given the mind set of the market fanatics in the governance towards public welfare, the fate of almost all the popular but secure small savings instruments are hanging in uncertainty as the goal is to divert the small savings to the share market.
This will be harmful to people at large though beneficial to few private (and foreign) fund managers.
It is, therefore, necessary that the decision of discontinuing PPF must be reconsidered. Constitution of PFRDA should not lead to scrapping of PPF in such an arbitrary manner.
As told to BS Bureau
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