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Suresh Krishnamurthy

THE Central Board of Trustees of the Employee Provident Fund and the Labour Ministry are at it again. For the third year in a row, both are objecting to a cut in the coupon rate on EPF balances.

The implication is that employees in the private sector should choose to invest in EPF over PPF this year also. That might give them a possible rate advantage.

Eventually, however, the Labour Ministry is likely to bow down to the wishes of the Finance Ministry. The controversy, though, needs a quick settlement this year, unlike last year when it took several months.

In the earlier years, the protests served the interests of the EPF investors. This time around, it is not clear. Indeed, fund management may be affected if the mess remains unresolved.

Successful protests: Since March 2001, the opposition from the Labour Ministry on an EPF rate cut has been strong. And it has been successful too. In 2001-02, the Ministry protested against the cut in the rate from 11 to 9.5 per cent. Result: EPF balances were credited with 11 per cent interest for 3 months and 9.5 per cent for the rest of the year.

In 2002-03, they protested the cut in rate from 9.5 to 9.0 per cent. Result: EPF balances will be credited with 9.5 per cent for 12 months.

In contrast, investors in General Provident Fund and Public Provident Fund will only get 9 per cent for 2002-03.

Will they remain successful this year too? That is highly unlikely. In the earlier years, EPF had the benefit of excess returns earned in the earlier years.

Since the interest rates in the economy have been declining, no such surplus may exist.

In fact, the labour ministry is asking for a subsidy - the difference between 9.5 per cent and what the fund earns. Given the state of the government's finances, the demand is bizarre and likely to be rejected outright.

In addition, last year, the difference between what they earned and what they wanted to credit was only about 0.5 per cent (9.5 minus 9.0 per cent). This year, the gulf is too wide at 1.5 per cent. In the end, there may be no option but to reduce the rate to 8 per cent — the rate fixed for GPF and PPF for 2003-04.

However, a higher rate might be applied for a part of 2003-04. As such, investors can opt for voluntary contributions to EPF rather than contribute to PPF in 2003-04.

There is only one disadvantage. For younger investors, amounts invested in EPF will remain locked in for a longer period compared to 15 years in the case of PPF.

That may be a small price to pay. In addition, since the funds will come in handy for retirement, it is not altogether a negative factor.

Changes needed: Fixing a rate higher than it is capable of earning is an invitation for unhealthy practices. Provident funds that are managed by companies on their own cannot earn 9.5 per cent per annum from the market given the prevailing yields. They might choose to invest in relatively higher risk instruments.

Funds are allowed to invest up to ten per cent in corporate securities. This ten per cent may find its way into higher return instruments with unsuitable risk profiles.

In addition, funds may invest in papers of high-risk State governments or State-government guaranteed bonds. These investments may haunt them in later years.

Concerns have been raised about the exposure of provident funds to State government paper.

Many of the State governments are in deep financial trouble and increasing exposure to such paper is not desirable for a provident fund.

In addition, even if they invest a portion in higher risk instruments, provident funds are highly unlikely to earn 9.5 per cent. Will they then be in default of the EPF rules?

It is clear that unlike in earlier years, the stubborn stance of the Labour Ministry may be counter-productive to the interest of EPF investors. The controversy needs to be put to rest at the earliest for this year and for all time to come.

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