Monday, May 30, 2005

The Provident Fund nightmare

Financial Express: Account at a discount

The board of Employees Provident Fund Organisation (EPFO) has announced 9.5% interest for the year 2004-05.

EPFO collects money from the employees and employers into a pension fund. The government pays a small percentage per employee into the fund as well. This money is invested on safe instruments like Government securities and the income earned from these interestments are used to calculate interest payable to the individual accounts of the employees.

All companies of a size above a certain norm are expected to open an account with EPFO. For example, any establishment employing at least 20 people should enrol in the EPFO. [At New Horizon Media Private Limited we are voluntarily joining EPFO with a staff count of 12.] All cinema theatres with at least a staff count of 5 should join the EPFO. There are exemptions in specific industrial sector, cooperative sector etc. The EPFO website provides details on which establishments must statutorily join EPFO. The employer contributes a sum, the employee a part, while the Government adds a small amount, each month.

As the interest rate in the country has steadily fallen, the money earnt by EPFO fund has dwindled. While EPFO paid 12% interest on the deposits in the past, it is unable to do so now. One of the main reasons for this is the EPFO is unwilling to consider other forms of investment, particularly the stock market. This has turned into a political problem with the left parties and their unions wanting the restoration of the unsustainable 12%. It appears that based on the current earnings, the best interest rate possible is only 9%. However, for the last two years, the government has been dipping into the reserves to offer an extra 0.5%. These reserves were built up when the interest rates were high in the country. While the left leaning unions have welcomed the recent announcement of 9.5% they want the Government to pay the deficit (and not dip in to the reserves). P.Chidambaram does not want to help from the Finance Ministry, as that would make his life more difficult and the fiscal deficit will needlessly increase.

I personally think my money will earn more if given to a private company which is willing to take moderate risks. However currently there is no provision for one or two employees of a given organization to break away from the EPFO. In future, the private pension funds may be authorized to manage the provident funds. The Ministry of Labour may identify a few companies along with EPFO as authorized entities. Then, the employee and the employer are given freedom to choose one of these few - the ones they trust.

I have personally opted for a private pension fund as well and their earnings are comfortably above 12% year on year - quite steadily. This is for a highly conservative investment choice. For those with a riskier bent of mind, the earnings are higher.

These are some of the suggestions:

1. EPFO must consider investing part of their funds in Indian stock markets which have matured considerably. It could be just 5% of the EPFO fund to start with. This percentage can be increased slowly once EPFO directors are confident that employees money is not wasted.

2. EPFO can entrust this money with Public Sector Financial Institutions such as LIC, and pay LIC nominal fees for managing this fund. LIC has been a very shrewd investor in stock markets and has earnt considerable profits from its stock market operations. EPFO need not worry about lack of talent within its own ranks in dealing with the stock market.

3. Private companies must be allowed in to manage the Provident Funds of employees based on user choice. This will be seriously resisted by the leftists, rather senselessly as usual. There is ample evidence that money invested with private financial institutions are earning more than EPFO.

4. The Finance Minister should never allow the left demand that handouts be given from the Finance Ministry to cover up for the deficiencies and demands of EPFO. However, at the same time, unlike what the Financial Express insensitively says ("One option is to allow the financial mess that the board is creating to get worse and then to shut down the EPFO."), the EPFO should not be allowed to collapse. This will seriously hurt close to 40 million individuals. Instead EPFO should be reformed immediately and the only reform I can see are the ones listed above.


  1. apparently the left's insistence on a 9.5% return from the epf will benefit only a very miniscule section of india's working population whom they claim to represent.

  2. Jagadish: Following from your blog post, I reached the Indian Express article. I think the IE article is mischievous.

    While I fault the left for certain mindless ideas, I do not think they are aiming to line the pockets of their trade union members. The author of that article is not clear on how pension reforms will benefit these poor sections, who are currently not within the purview of the EPFO.