The hike in the provident fund interest rates to 9.5 per cent announced by the finance minister has put the Employees Provident Fund Organisation (EPFO) back into the headlines. However, all the discussions on provident funds have left out an important piece in the provident fund story- the employers who run exempt funds.
Exempt funds in India are the private equivalent of occupational pension funds. Employers who are covered under the EPFO, but who want to set up their own trusts and provide benefits to their employees seek an administrative exemption from the EPFO. As per EPFO annual reports, there were 2,564 exempt funds with 38 lakh members in 2002-03 with contributions of 34 per cent of the total contributions towards the EPFO. These employers are required to set up separate trusts, invest employee contributions as per EPFO investment guidelines (as notified by the ministry of finance) and credit at least the rate that the EPFO gives to its members. If the exempt fund is unable to meet the mandated interest rate, the employer is required to meet the gap from his balance sheet.
What does this 9.5 per cent mean for the employer? For the past two years, the EPFO has also found it difficult to earn 9.5 per cent from its investments on account of low yields on government paper. The situation is similar for several of the exempt funds as well. Investment regulation that until recently only permitted investments in debt instruments and falling interest rates have made it difficult for the funds to earn an interest rate of 9.5 per cent. What this effectively means is that the 9.5 per cent decision will impact the balance sheet of employers. The employers will now have to transfer resources from their shareholders to their employees which is in essence a tax on the employer. The recent provisions to invest in equity are effective only from April 1, 2005 and therefore do not impact the ability of the funds to credit interest for 2003-04 and 2004-05. For the past two years, the EPFO had not ratified any interest rate. As a result, several exempt funds have been crediting typically an interest rate of 8.5 per cent, owing to lack of clarity and direction from either the government or the EPFO. The recent announcement implies an administrative nightmare for these funds. They will now have to credit the extra 1 per cent on account balances.
The other problem with the investment regime is that the PF Trusts' access to live prices and AAA rated assets are restricted because these are typically not traded in retail lots. Market lots (inter-bank lots) for bonds are INR 5 crore and above leaving most exempt funds out as they do not have investible surpluses of this amount. This restricts access to such bonds for PFs, as they are left with bonds of riskier and lower rated government companies, for example, electricity boards. Exempt funds are forced to buy securities from smaller brokering firms who pose settlement risk. The cost on the employers is even more ironic when one looks at the motivations of the employers seeking an exemption in the first place.
Exemptions are sought primarily with an intent to provide better service to employees, which the EPFO has not been able to do with its poor administrative processes. The EPFO also levies a huge administrative fee on the employer- 4.5 per cent of contributions which is high by any standards. Thus requirements of a 9.5 per cent interest rate put the very employers into difficulties who have taken that extra effort to provide better services to their employees.
There have been complaints from the EPFO about defaults by the exempt funds. However a close look at the data shows that the defaults are not specific to exempt funds alone and employers who are members of the EPFO have not shown considerable difference in compliance. The current scheme of things with a high administrative cost of the EPFO, stringent investment regulations and a mandated interest rate does not augur well for the development of an occupational pensions market in India.
The government recently brought out an ordinance paving the way for the establishment of a new pensions regulator and an individual account defined contribution system with professional fund management. The government should look into integrating these exempt funds into the New Pension System to create a level playing ground for the employers and a sound retirement system to the employees.
The writer is a research associate with India Pension Research Foundation, New Delhi.
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