Priority beyond returns

The EPFO should increase transparency

The Central Board of the Employees’ Provident Fund Organisation (EPFO) last week recommended maintaining the interest rate at 8.5 per cent for this fiscal year. The payment would be made after the recommendation is accepted by the finance ministry. Clearly, the return on EPF contribution is significantly higher than any fixed-income option for its 50 million subscribers. The State Bank of India, for instance, is offering less than 5 per cent for fixed deposits of one-two years. The yield on 10-year government bonds is at about 6.2 per cent, and was even lower in 2020. Besides, the EPF interest income is tax-free, which further increases the return differential. But this may not be sustainable in the long run.

A significant part of the EPFO’s earnings in the current year has been boosted by buoyancy in stock prices. There was initially a fair bit of reluctance in terms of putting EPF money in the equity market. However, now it is being able to give higher returns, partly because the stock market has done well. Investing longer-term funds in the equity market makes sense because stocks tend to perform well compared to other assets, particularly fixed-income instruments, in the long run. But this is not to suggest that equity outperforms other assets every year. There are times when the stock market witnesses excessive volatility and lower returns. The overall returns also depend on the kind of stocks selected. It was reported last year that the EPFO lost money in the stock market, partly because of its considerable investment in government-backed exchange-traded funds. Public sector enterprises in India are not known for value creation. Thus, instead of supporting the government’s disinvestment programme, the objective of the retirement fund manager should be to maximise risk-adjusted returns for its subscribers.

At a broader level, while the retirement body has recommended a higher 8.5 per cent interest rate for the current year, it would need to manage subscriber expectations in the future because the returns may have to adjust to the wider macroeconomic realities. The finance ministry has also suggested in the past bringing rates closer to market realities. In the context of fixed-income instruments, it is important to recognise that a fundamental shift is happening in the Indian economy. Both the average inflation rate and volatility in prices have come down after the adoption of the flexible inflation-targeting framework. As a result, it is likely that nominal interest rates would remain considerably lower than the 8.5 per cent mark — though interest rates may go up from the present level in the near term because of a higher fiscal deficit.

The retirement fund manager may decide to increase equity allocation to boost longer-term returns. However, to be able to align returns to market realities, the EPFO will need to increase transparency. It needs to disclose its investment and performance to subscribers at regular intervals. More information in the public domain will result in analytical scrutiny and debate, which would also help the retirement fund manager make better decisions. Annual EPF returns may not remain disconnected from the markets for long. Transparency and better disclosure norms would make the transition easier.