Economy Dec 12, 2012
By R Jagannathan
If your mutual fund manager has a poor performance record, and also offers you poor service, would you still entrust more of your money with him?
Probably not. But the Employees Provident Fund Organisation (EPFO) - the organisation to whom the government has entrusted your retirement savings - has decided that it is the cat's whiskers when it comes to managing your money. It has demanded a bigger chunk of your salary as monthly contributions.
As Firstpost reported, this will happen by clubbing all allowances (special allowance, education allowance, etc) together for the purpose of calculating the 24 percent of salary that you and your employer currently contribute (12 percent each) into the EPFO every month. EPFO argues that employers pay part of salary in allowances outside the basic and dearness allowance framework in order to reduce their payouts to the EPFO.
But, in truth, this is not just a ploy created by the employer. The employee too benefits by increasing his takehome pay.
In theory, the EPFO move - which is apparently the result of some recent court verdicts - will result in lowering your takehome and instead offer you a higher retirement kitty. In practice, we may end up with a mess that will be bad for the employer, bad for the employee, and bad for the government.
It will be inflationary: If your monthly PF deductions go up in an inflationary scenario, the chances are the unions and other wage earners will demand pay hikes to retain existing takehome pay. This means the underlying pressure will be inflationary. Your employer will pay more, and you will demand more.
It will lower returns: We are now entering a lower interest rate scenario due to slowing growth. Raising provident fund contributions right now will mean lower returns since the only instruments the EPFO can invest in are super-safe government securities, where yields could start coming down. Since the EPFO can't invest in equity or gold or other assets, your returns will trend down. Last year, in the year to March 2012, the EPFO paid 8.25 percent - far below the Public Provident Fund rate of 8.6 percent or bank fixed deposit rates of 9-9.5 percent at that time.
It will increase pressure for government bailouts: The EPFO has not been doing a great job of managing your money. Even though the organisation's board of trustees tries to maintain high payouts every year - even higher than what it earns - the problem is that when inflation is still in double-digits, making payouts of 8.25-8.5 percent will not be acceptable to most unions. So the trustees keep asking the government to top up the money, which can only increase the fiscal deficit.
It will be like rewarding poor performance: The EPFO has a very poor record of service to its subscribers, and its record in managing money is even poorer. In 2010-11, the EPFO paid 9.5 percent claiming that it had a huge surplus on its books. But it seems the surplus was the result of a miscalculation, and the next year the payout had to be reduced to 8.25 percent. Not only that, the EPFO charges huge administrative fees of 6.7 percent, reports Business Standard - a high cost for the privilege of mismanaging your money. The EPFO is also a hotbed of corruption - which is why employees run from pillar to post to get their retirement dues.
In such a scenario, what we should be talking about is a winding down of the EPFO, and not giving it a larger mandate and corpus. The Rs 3,50,000-and-odd crore it manages on behalf of nearly 4.8 crore Indian wage-earners is already way too high for its competence.
So what is the way forward?
Given the fact that the EPFO is implicitly guaranteed by the government, workers and unions are not going to allow provident funds to be managed by private parties, which is the case with the New Pension Scheme (NPS) - which guarantees no returns, but gives contributors freedom to decide their asset allocations between equity and debt.
One simple remedy is to mandate the EPFO to only manage contributions upto a certain amount - leaving the balance to be managed by the NPS, depending on what the individual employee wants.
For example, if funds up to, say, Rs 20,000 a year go to the EPFO, and the employee can then invest the balance in NPS according to his risk profile, those at the lower end of the wage scale will benefit from the implicit government guarantees for the EPFO even while allowing the better off contributors to move to the NPS, where investments in shares are permitted.
The EPFO needs to be contracted and focused on the poor where government guarantees are important. The rest should be migrated to the NPS.
Like T-Rex, the EPFO has become too big to be managed efficiently.