Perverse policy signals

Perverse policy signals
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First Published: Sun, Jul 05 2009. 08 53 PM IST
Updated: Sun, Jul 05 2009. 08 53 PM IST
If policy signals are anything to go by, the execution of economic reforms remains as difficult as ever. After an anti-reforms Railway Budget comes the decision of the Employees Provident Fund Organisation (EPFO) to continue with an 8.5% interest rate on EPF subscription. This is an indicator of how no one wants to tackle the issue of interest rate distortion created by political compulsions.
The central board of trustees (CBT) of EPFO on Saturday recommended an 8.5% interest rate.
CBT also ruled out investing 15% of its Rs1.82 trillion in select equities, a decision that spells business as usual for EPFO.
This deserves comment.
India is witnessing a move to a low interest rate regime. Not only has the government pushed the banking system towards lower interest rates, the macroeconomic environment, too, is moving in that direction. The rise in lending risk, too, has peaked. In this situation, EPFO did not address the issue of finding high-return investment opportunities. Given EPFO’s risk preference for “fail-safe” investments, such opportunities do not exist in the Indian economy.
The more serious concern at the moment is how EPFO and other government-mandated investment vehicles, such as the small savings schemes, distort the interest rate structure of the economy. Banks simply can’t reduce their interest rates below the rate offered by these entities. As a result, there is an inbuilt upward bias in lending rates that affects the economy in a perverse manner.
The government and these organizations, however, could not care less.
EPFO has, for example, maintained the 8.5% return rate for five consecutive years. It does not, and will not in the foreseeable future, realize that it is part of the Indian economy: The damage it inflicts via its interest rate demands rebounds on it, too.
The issue that looms large in all this is the government’s lack of will in arresting this political economy of decay.
To talk of economic reforms in an environment where politicians are unwilling to take hard decisions and government employees remain stubborn is at best an economist’s dream.
And now, at least, that dream seems deferred.
Are high provident fund rates a sweet poison? Tell us at views@livemint.com
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First Published: Sun, Jul 05 2009. 08 53 PM IST