EPFO Paradox | Value Research Subsidy on the interest paid on savings is, in effect, a subsidy on the possession of money. As a result of an EPFO subsidy, the more money you have, the more money you will get from the government
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EPFO Paradox

Subsidy on the interest paid on savings is, in effect, a subsidy on the possession of money. As a result of an EPFO subsidy, the more money you have, the more money you will get from the government

A couple of days ago, there was news that the Finance Ministry has said that the Employee's Provident Fund Organisation (EPFO) shall be able to invest up to five per cent of its new deposits in the stock markets. Most commentators assumed that this was it and the EPFO's stock investments would now actually happen. However, the EPFO's trustees' board rejected the idea as too risky. Also, the EPFO board asked the finance ministry for support to pay a higher interest rate. The current rate is 8.5 per cent. The board wants to maintain this rate but that will require the government subsidies. The EPFO's own finances suggest that only 8 per cent is feasible while the left trade unions reportedly want 9.5 per cent.

This has brought forth the now-periodic argument about whether the EPFO interest rate ought to be subsidised. Obviously, the unions and politicians of many colours want the government to subsidise the interest rates and 'finance ministry sources' that the pink newspapers often quote warn of how the subsidy will balloon up to an unaffordable size. Generally speaking, all involved knees have reacted by jerking in thoroughly predictable directions.

I think that this EPFO subsidy issue needs some dissection of exactly who is being subsidised and on what basis. It isn't anybody's case that there should be no subsidies at all in the country. Clearly, there are many things that ought to be subsidised. For example, school education and healthcare for the poorest Indians are surely good subsidies. However, a subsidy on the interest rate paid on savings is, in effect, a subsidy on the possession of money. As a result of an EPFO subsidy, the more money you have, the more money you will get from the government. The arithmetic is simple-if your provident fund balance is Rs 10 lakh, a one per cent subsidy means that the government will gift you ten thousand rupees a year. But if your balance is just Rs one lakh, then that same one per cent subsidy means that the government will gift you only a thousand rupees a year. And so on. The poorer you are, the less the government will subsidise you.

In my opinion, this bizarre and patently unjust reverse subsidy phenomenon is happening because of a failure to differentiate between different classes of EPFO beneficiaries. Everyone's mental image of an EPFO account holder is that of a peon or a manual labour. My hunch is that while such workers will form the greatest number, a relatively larger amount of EPFO assets will actually come from a smaller number of much better-paid employees. The poorer EPFO beneficiaries typically don't have the knowledge or the confidence to look for other investment avenues and in any case, often don't have any other savings except whatever is enforced by their EPF deductions. Often, their EPF savings are their entire savings. The cause of this class of EPF holder should not be mixed up with that of the better paid employee for whom the EPF is a small part of his personal asset base.

Generally speaking, the ideal solution to the EPFO's troubles is to transform it into an efficient organisation that manages its funds professionally in various debt and equity markets and then delivers to its investors whatever it earns after deducting (hopefully low) expenses. But for a variety of reasons, this is not going to happen in a hurry. If the EPF beneficiary has to be subsidised, then surely even those who are clamouring loudest for the largest subsidies would want these subsidies to concentrated only to that subset which needs them most.



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