The Employees' Provident Fund Organisation (EPFO) must manage workers’ savings more efficiently to help them build a respectable retirement nest. The 8.1% rate of return that the Central Board of Trustees of the EPFO has recommended for 2021-22—although better than the interest rate on bank deposits and small savings schemes (ranging from 4.0% to 7.6%)—is not just lower than the 8.5% return in the previous financial year, but also the lowest in four decades. It is also lower than that generated by the National Pension System (NPS). This is when interest rates around the world are heading north; a telling reflection of inefficient fund management.
Labour minister Bhupendra Yadav has said the EPFO cannot take very risky investments and favours stability. But it is more likely that worries about the possibility of incurring deficits have led to the decision of reducing the rate. With vital state assembly polls over and out of the way, taking the decision to reduce the rate would only have become easier. Reportedly, the EPFO has liquidated ₹12,785 crore worth equity investments in exchange-traded funds and will use capital gains of around ₹5,529 crore from it for the 2021-22 interest payout. It will be left with an estimated surplus of ₹450 crore after the interest 8.1% payout. Retaining the interest rate at 8.5%, the level of last year, would have resulted in a deficit of ₹3,500 crore.
For, the EPFO’s investment pattern is quite conservative even today. A bulk of the exposure of the EPFO corpus is in debt instruments, mostly public, while the exposure to equity is capped at 15% of the corpus. However, the total corpus of ₹9.4 lakh crore is sizeable enough to be diversified across asset classes to generate higher returns, while reducing risk. A more flexible approach in the allocation of the corpus across different asset classes will obviate the need for the government (most often) to subsidize the return for over 6.7 crore contributing subscribers.
But it is no secret that the EPFO’s track record of managing workers’ funds has been abysmal. Way back in 2000, the Project Oasis Report, which formed the basis of the New Pension System, noted that the EPFO was failing on the core goal of accumulating pension savings for participants due to its inefficient fund management. Things did not change for the better. Almost a decade later, the EPFO discovered an accounting error that had left the fund with more money than it knew it had. All this made the financing of its payout opaque.
Rightly, in the 2015-16 Budget, the government had said that workers would be given a choice to migrate to the NPS—a defined contribution scheme launched for government employees joining service from January 2004, and later open to voluntary subscribers—that generates better returns. But the proposal remained on paper. The government should urgently revive the proposal by amending the EPF Act.
Today, the yield on 10-year g-secs is about 6.8%, about 130 basis points lower than the return on EPF. The absence of long-dated paper that yields higher returns also poses challenges. Moreover, contributions to the EPF dented due to the pandemic that triggered huge withdrawals. Now, the Russian-Ukrainian situation has added to market uncertainty. But even in the best of times, the EPFO has shied away from asset diversification—such as investing in private equity or venture capital funds—and instead opted for bonds polished with equity.
In contrast, the three-year return of the NPS even for government employees, who have the option now to invest up to 50% in equities, is about 240 basis points above the EPF’s.
“The terminal wealth at the age of 60 is highly sensitive to the rate of return. A one percentage improvement in the rate of return from 12% to 13% has the potential to yield a 20% higher corpus at the age of 60. Improving the rate of return, without sacrificing the long-term safety of funds, is possible by appropriate changes in investment guidelines and appointing professional fund managers," as per the Oasis report.
That holds even today. The larger point is to have the right trade-off between risk and return. So, the way forward would be to let workers not lose out on the opportunity to switch to NPS, access low-cost fund management expertise and earn higher returns on their retirement savings.
