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Suresh Krishnamurthy

Fixing an inflation target and making the Government pay if the target is breached may be a balanced solution to the vexatious problem of setting interest rates for employees' provident fund. That could permanently resolve the crisis, which has now become an annual ritual.

IT HAS now metamorphosed into an annual ritual. The setting of interest rate to be paid on balances in employees' provident fund (EPF) accounts has been beset by controversy ever since the Government started reducing the administered rates.

The demands made this year for an interest rate that is significantly higher than 8 per cent appears unreasonable. A better course to adopt would be to force the Government to commit to a specific inflation target. Any failure of the Government to control inflation should automatically trigger payment of higher interest.

The trade unions themselves appear to be exploring the possibility of inflation-indexed payments. If the trade unions were able to use their leverage with the Government and gain the Government's assent for inflation-indexed interest rate, it would be a significant victory. It would also resolve this annual crisis perma- nently.

For the Government, it may not be easy to give into demands for inflation-indexed payments. This is because similar treatment would have to be given to Government Provident Fund and Public Provident Fund. Besides, inflation is not wholly dependent on the Government's fiscal strategies.

In addition, 8 per cent plus an inflation-indexed payment does not appear feasible. Innovative solutions, however, can be found. Inflation-indexed payment is a reasonable and fair solution that will balance the demands of both the Government and employees in the organised sector.

Unreasonable demands: Contributions flowing into the treasury of the EPF are predominantly invested in a special deposit scheme with the Government. The Government has been reducing the interest rate payable on this scheme and it now stands at 8 per cent.

Until this year, the surplus in the EPF accounts generated in earlier years was used to set an interest rate that was higher than what the fund earned during the year. For 2003-04, the Central Board of Trustees of EPF paid 9.5 per cent. This year the fund does not have any such surplus and cannot afford to declare more than what the Central Government pays. To continue paying larger sums, the trade unions are demanding that the Government dole out a subsidy.

These demands are unreasonable for a couple of reasons. Balances in Government Provident Fund and Public Provident Fund are getting credited with lower interest rate than EPF balances for some years now.

Until this year, this was justified because the Government was not footing the higher bill. This year, if the Government were to accede to this request, it would place private sector employees on a higher pedestal compared to public sector employees and workers in the unorganised sector who contribute to PPF.

In addition, the eight per cent rate itself is quite reasonable. A ten-year government security is now yielding about 6.2 per cent. After tax, this ten-year security would offer investors between 4.3 and 5.5 per cent.

In this context, a tax-free rate of 8 per cent plus a tax incentive in the form of tax rebate for employee contributions is more than appealing. At 8 per cent, investments would double in nine years — not bad for a risk-free investment.

Inflation target appealing: If long-term security of contributors to the provident fund account is the relevant consideration then an inflation-indexed payment is a possible solution.

Here too, a complete inflation-indexed payment may actually be counter productive especially if the economy grows faster.

Faster economic growth and strong rupee will lead to a decline in inflation and, therefore, lower payments.

Thus a mix of fixed payment and an option for higher payment if inflation breaches a specific target sounds appealing.

For instance, for 2004-05, a 7 per cent interest payment plus a payout of 0.5 per cent for every 1 per cent rise in average weekly inflation for the year above 5 per cent could be an acceptable proposition.

The payout of 7 per cent is fair consideration for the long-term investment with the Government. The payout for inflation would be the social security component.

The 7 per cent payout would be negotiable each year and be linked to the trends in the movement of interest rates. The inflation payout, which is the social security component, would be non-negotiable.

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