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The reason why PF interest rates were lowered

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Photo: Mint

The Employees’ Provident Fund Organisation (EPFO), recently, slashed interest rates on provident fund (PF) deposits for 2021-22 from 8.5% to 8.1%, the lowest in over four decades. Mint explains the logic behind the decision

The Employees’ Provident Fund Organisation (EPFO), recently, slashed interest rates on provident fund (PF) deposits for 2021-22 from 8.5% to 8.1%, the lowest in over four decades. Mint explains the logic behind the decision:

How does the EPFO secure  workers’ future?

The EPFO was established by the Employees’ Provident Funds & Miscellaneous Provisions Act, 1952. It aims to provide provident fund (PF) for workers in Indian factories and establishments where at least 20 people are employed. The contribution towards PF aims to take care of a person’s post-retirement needs and the investments are government-backed. The EPFO comes under the labour ministry and is administered by a tripartite board—the Central Board of Trustees—which has representatives from the government, employers, and employees. It has more than 60 million active subscribers.

How are PF interest rates set?

To be able to pay interest, income must be generated through appropriate investments. As per the guidelines and to ensure that the Trust’s money is safe and offers optimum returns, it is mandated to invest 85% of its corpus in debt instruments and 15% in equities. With interest rates on fixed deposits on an average hovering around 5-5.5%, national savings certificate at 6.8%, and public provident fund offering 6.8-7%, it was only logical to expect that interest rates on PF will be brought down. In case of earnings falling short of declared interest rates, the government would need to subsidize the same.

In the line with market rates
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In the line with market rates

How will it impact the common man?

Lower interest rates will adversely impact those who bank on their PF deposits to accumulate retirement fund. However, it is also important to bear in mind that with interest rates on an average being on a declining trend, high rates maintained by the EPFO have been questioned. PF interest rates should be reflective of the state of the Indian and global economy.

What is the impact of PF interest on budget?

Due to the pandemic, the fiscal deficit for 2021-22 has doubled to 6.9% of gross domestic product (GDP). India might end the year with a wider fiscal deficit and economic growth numbers might have to be revised, with the Russia-Ukraine war driving up crude oil and commodity prices and leading to supply chain disruptions. In this background, increased PF subsidy means greater government borrowing and pushing interest rates up, the consequence of which ultimately will be cost-push inflation.

So, what is the way out?

In countries like India with a comparatively weak social security system, the importance of returns on savings cannot be ignored. There needs to be a balanced approach towards risk and returns. Exposure to investment by the EPFO in equity shares may be raised up to 50%. An option could be offered to the employees in terms of risk exposure. There could be different schemes where employees are given the opportunity to choose.

Jagadish Shettigar and Pooja Misra are faculty members at BIMTECH.

 

 

 

 

 

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