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Pension Reforms are Here. Not.

Equity investments have been allowed for private PFs but the move is unlikely to have impact without broader reforms

In a notification issued today, the government has permitted non-government provident funds, pension funds and gratuity funds to dabble in shares. From April 2009 onwards, such funds will be able to invest up to 15 per cent in equity. Only those stocks which are on the NSE or the BSE’s derivatives list are eligible.

While the shift is a step towards pension sector reforms, these are not the big pension sector reforms everyone is waiting for. This step may not bring about too much of a change in the way these funds are managed. The reason is that for all practical purposes, private PFs have to match the EPFO’s guaranteed returns every year. Doing that could be difficult in a volatile equity market.

In theory, adventurous managements could try and capture some equity returns while trying to hedge against losses, but the incentive to do so would be minimal. And that’s unlikely to change until the entire pension sector shifts from a defined-benefit to a defined-contribution paradigm.

Besides permitting equity investments, the notification also made other changes in the investment pattern. All the changes provide considerably more flexibility in managing PFs. Here’s a comprehensive list of the announced changes

  • Merger of Central Government Securities, State Government Securities and units of gilt mutual funds into a single category and allowing investment up to 55% of the investible funds;
  • Providing a flexible ceiling for various category of instruments instead of fixed investment ceiling as at present;
  • Providing new category of instruments, such as, rupee bonds of multilateral funding agencies, money market instruments ;
  • Permitting investment in term deposit receipts of not less than one year duration issued by scheduled commercial banks subject to the specified financial criteria; and
  • Permitting direct investment up to 15% of the investible funds in shares of companies on which derivatives are available in the Bombay Stock Exchange or National Stock Exchange.
  • Freedom to exit from a rated financial instrument when their rating falls below investment grade.
  • Freedom of trading of securities, subject to the turnover ratio (i.e., the value of securities traded in the year divided by average value of the portfolio at the beginning and end of the year) not exceeding two.
  • Flexibility of exceeding the investment ceiling up to 10% of the limit prescribed during the year.

Of course, politics may yet scupper the actual implementation of these new rules. By April next year, when the changes will come into force, elections would already be over and there may well be a new government in Delhi which is on a left-powered life support system.

Keep your fingers crossed.