Why FM Jaitley’s move to cut EPF rate is good economics, but bad politics

The decision of the Finance Ministry to lower the Employee Provident Fund (EPF) interest rate to 8.7 per cent—10 basis points (bps) lower than what the Central Board of Trustees (CBT) recommended has irked trade unions, including the RSS-backed Bharatiya Mazdoor Sangh. The primary reading from this action would be that Finance Minister Arun Jaitley has yet again failed to read the pulse of the working class when it comes to managing their pension funds.

PensionThinkstockThere have been two instances in recent months when the government has acted on the EPF issue but had to reverse its decisions on account of major public backlash. First, when the government proposed in the 2016 Union Budget to tax 60 per cent of the EPF corpus, which it had to roll back almost immediately on account of mass protests. Second, when the amendment on the age limit to withdraw the retirement corpus to 58 years from 54 earlier was brought in, only to roll back after trade unions protested. Why it is playing with fire a third time fully knowing that EPF concerns a large, complex beneficiary group and is a politically sensitive issue?

The explanation lies in the overall agenda of the Narendra Modi-government to align the savings rates in the country required to bring down the lending rates in the banking system, which is in turn, needed to boost a sagging economic growth. As a first step, the government moved to lowering the returns on small savings schemes in the economy when it lowered interest returns on post office savings and other small savings schemes having shorter tenure.

A one year post office deposit will now yield a return of 7.1 percent as against 8.4 percent before. Similarly, the rate on Kisan Vikas Patra has been revised downwards to 7.8 percent from 8.7 percent and that of Sukanya Samrudhhi account scheme has been lowered to 8.6 percent from 9.2 percent. Also, the Public Provident Fund rate has been dropped to 8.1 percent from 8.7 per cent. This gives room for banks to cut their deposit rates.

The reason is simple: A major reason banks have been hesitant to slash lending rates, so far, was the high deposit rates in the banking system. Without deposit rates coming down, banks cannot cut their lending rates since it will hit their margins. But, deposit rates couldn’t be lowered on account of the comparatively higher returns on small savings schemes and post office deposits. With small savings rate coming down now, the stage is set for a drop in bank lending rates as well.

The reduction in savings rate, with the implementation of a new rule from the Reserve Bank of India (RBI) requiring them to set their lending rates based on their marginal cost of funds unlike the average cost of funds in the past, will do the trick in lowering their lending rates in the banking system. Remember, despite the RBI cutting its key lending rate, repo, by a total of 150 basis points since the beginning of the rate easing cycle, banks had passed on only about half of the rate cut to the end-consumer, highlighting the high savings rate in the economy and ineffective base rate regime. With both issues addressed, lending rates will fall now. The EPF rate reduction should be seen in that context.

Secondly, the argument that a 10 basis points reduction in the EPF rate will damage the retirement kitty of the pensioners is a baseless fear in the current context. In a scenario when the inflation is falling (CPI inflation is hovering around 5 per cent and the RBI is on course to bring it down even further), the real returns will be positive. In that sense, an 8.7 per cent rate of return is not at all bad.

In the backdrop of the ongoing state elections, it is a politically bad move for the government. Trade unions have already outlined their battle plans. “The reduction of the rate is against the rights of the CBT and the EPFO. The Finance Ministry’s attack on the organisation had started in the Budget and it is still continuing. This is a very serious attack. We will go for a nationwide stir against the government after discussions with other central trade unions,” CITU president A K Padmanabhan said.

‘It doesn’t make sense to artificially protect one asset class,” said D K Joshi, chief economist at Crisil, the Indian subsidiary of Standard and Poors. “Directionally, the government’s decision to cut EPF rate (compared with the original proposal of CBT) is a positive step,” Joshi said. The short point here is that the government’s move to settle for a lower than recommended EPF rate is a bold move. It’s something a decision to guide the economy to a lower interest rate regime.

(Data Support from Kishor Kadam)   


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Updated Date: Apr 26, 2016 12:16:13 IST

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