Column

The Employees’ Provident Fund Organisation (EPFO) of India was set up in 1952 with the mandate of providing retirement income security to the organised labour force in the private sector.

As India’s calibrated globalisation increases the role of the private sector, the need for a professional and competent organisation to undertake such a mandate becomes even more vital.

It is increasingly clear that EPFO’s current organisational culture and mindset, governance structure, design of schemes, and outdated technology and human skills are not conducive to fulfilling the above mandate. Indeed, the cost imposed by the EPFO on its members, on businesses, on the economy and all other stakeholders is far larger than the benefits provided.

The outmoded organisational structure and culture is reflected in the fact that even after 55 years of operation, EPFO has been able to bring under its purview only about 4,40,000 establishments (about the same number as Employee Provident Fund of Malaysia with a population of 24 million), and about 40 million members (though due to multiple accounts and inactive membership the actual contributors in any given month is only about 20 million, equivalent to only 4.3% of India’s 460 million labour force).

EPFO, with total employee strength of 19,000 and total assets of Rs 1,49,800 crore ($36.5 billion), is India’s largest non-banking financial institution (NBFI).

It is, however, administered as if it were a welfare organisation. It is governed by an unwieldy and dysfunctional 45-member board of trustees headed by the Union labour minister.

Administrative matters are under the control of the central provident fund commissioner, who is the chief executive officer of EPFO.

Thus, while the board has a bureaucrat at its head, the Central government appoints all the members, and a Cabinet minister has the final authority on all critical policy and personnel decisions.

Given the short-term nature of the political cycles, it is not surprising that the above board structure does not provide sufficient weight to long-term considerations, essential in managing the national provident fund.

The EPFO is an unusual national provident fund in combining the features of a defined benefit scheme (Employees Pension Scheme or EPS, introduced in 1995) with those of a defined contribution scheme (Employee Provident Fund, or EPF) for its members. While the EPF balances can be withdrawn as a lump sum, the EPS is a pension scheme, with survivor benefits.

The EPS scheme is badly designed, as it fixes (defines) both benefits and contributions. This is mathematically impossible. As the scheme parameters change over time, either benefit formula and/or contribution must be changed for financial sustainability.

If both are fixed, the scheme cannot be sustainable. This is demonstrated by the reported under-funding of Rs 25,000 crore, equivalent to one-sixth of its total assets. Moreover, in the absence of reforms designed to match its long-term assets and liabilities, the under-funding is expected to grow rapidly.

Contrary to normal financial practices, the EPFO Board deliberates on the interest rate to be paid to members at the beginning rather than at the end of the financial year.

The EPFO trustees, grossly neglecting their fiduciary responsibility towards members and the taxpayers, have been engaged in attempting to secure through political and administrative means higher interest rates for the members than what their unprofessional and uninformed investment policies permit the funds to earn.

From a national point of view, budgetary support to EPFO is not likely to benefit the aam aadmi, as 85% of the members had balances of less than Rs 20,000, accounting for 17% of total balances. There are also more pressing needs for the government’s fiscal resources.

One of the techniques used to sustain such imprudent financial practices has been to use balances in the ‘suspense accounts’ to pay interests.

The unclaimed contributions and interest payments are deposited in the suspense account, whose large size is a reflection of the inefficiencies in EPFO’s accounting and administrative practices. This makes the practice also inequitable as those individuals whose contributions have not been credited subsidise others.

The opportunity cost of disproportionate energies spent by the Board on the interest rate to be declared is the neglect of issues related to long-term financial sustainability, including using modern investment strategies for earning risk-adjusted higher net returns for its members.

The EPFO does not have a professional investment or treasury department for managing funds, and has always outsourced the investment function to RBI and SBI.

Its dogma of investing overwhelmingly in public sector debt has meant that the EPFO members have not benefited from the divestment of such blue-chip state enterprises as Indian Oil Corporation and Maruti-Suzuki. The Board must be held accountable for the foregone earnings.

India’s stock market capitalisation exceeds $1 trillion. The depth and breadth of its financial and capital markets, which permit market-based efficient intermediation between savings and investments, are among India’s most important competitive strengths.

That the board of trustees of India’s largest NBFI consciously refuses to utilise this competitive strength is astonishing. Even more astonishing is the argument made by trade union members of the board that such refusal is in the interest of the workers and the country.

EPFO as regulator illogically requires that the exempt funds must have the same investment pattern, and pay at least the same interest rate as the EPFO.

Yet, some of the well-managed exempt funds are able to generate better returns and quality of service at lower transaction costs than the EPFO.

Higher returns than EPFO by exempt funds attract income tax, encouraging inefficiency and stifling financial innovation. One of the essential characteristics of good governance is that a service provider should not also be a regulator. This must be applied to the EPFO.

As the Prime Minister has been rightly communicating to the EPFO, it must learn to earn, and pay what it earns. Unless the EPFO reorganises around this principle, and envisions itself as an internationally benchmarked service provider for the benefit of all its stakeholders, it runs the risk of becoming increasingly irrelevant.

Mukul G Asher: Professor of Public Policy, National University of Singapore
Amarendu Nandy: Research scholar, LKY School of Public Policy, Singapore