Rate hike by EPFO shows lack of professionalism, misuse of regulatory power

It has been nearly two weeks since the Employees’ Provident Fund Organisation (EPFO) announced a hike of one percentage point in interest rate on its Employees’ Provident Fund (EPF) scheme for 2010-11 to 9.5%.

EPF is a defined contribution scheme under which member receive accumulated balances in lump sum at the specified age of withdrawal. As at March 2009, the scheme had accumulated investments of `2.33 lakh crore, amounting to 4.2% of the country’s gross domestic product (GDP).

In addition to EPF, the EPFO also has the responsibility of administering a defined benefit pension scheme called the Employees’ Pension Scheme (EPS), which had accumulated balances of `1.08 lakh crore (equivalent to 2% of GDP) and the Employee Linked Life Insurance Scheme, which is of relatively minor importance. EPS faces an actuarial deficit of `54,000 crore (equivalent to 1% of GDP), the EPFO has acknowledged.

The combined mandatory contribution collected by the EPFO is 25.68% of the wages, a high statutory cost on the covered members and their employers. Its responsibility is to provide services to its members commensurate with the contributions.

The EPFO’s announcement has been welcomed by members with operative accounts who will receive the 9.5% interest rate for 2010-11. But their short-term positive feelings must be tempered, as the reasoning and manner of announcement of the interest rate raises serious medium-term concerns about the capabilities of the EPFO to be a professional, transparent, and accountable provider and regulator of provident and pension fund services.

The reasons for the above assessment may be summarised as follows.
First, the interest rate for 2010-11 has been announced before the financial year is over. That this practice has been continuing since 1952 when the EPFO was established without any questions raised by those in charge of the EPFO is simply astonishing. The proportion of time spent by the Board of Trustees in political posturing on the level of interest rate to declare, while neglecting enhancement of the EPFO’s abilities to earn higher returns, raises serious concerns about its fiduciary responsibilities.

Second, the EPFO Commissioner has indicated in a recent interview that the reason for declaring the 9.5% rate —- which he acknowledges is not sustainable —- was the balance of `14,696 crore in the Interest Suspense Account (ISA). He stated that the Board of Trustees considered this amount to be too large. So the recalculation of the balance sheet from 1952-53 (over 57 years) was undertaken to estimate how much interest had accrued, and how much was surplus. The ‘surplus’ is pegged at `1,731 crore on an accrual basis. Neither the amount payable to individuals nor the so called ‘surplus’ has been defined in a transparent manner.

The Commissioner indicated that the EPFO operates on cash budgeting concepts, but that for the purpose of calculating the surplus, they used accrual budgeting methods. This is curious as the EPFO has been resisting a shift from cash to accrual budgeting for many years, even when the case for such a shift is strong.

That for the purpose of calculating one-off higher interest rate the EPFO was willing to undertake recalculation for the past 57 years, when its services are poor and recordkeeping and management information systems have been not modernised —- the Commissioner acknowledged that an astonishing 40% of the accounts with the EPFO are inoperative, and henceforth they will not receive any interest on their balances —- suggests misplaced priorities.

The EPFO Commissioner’s understanding of the accrual method of budgeting also appears to be in urgent need of upgradation. It is not clear if the EPFO will operate on cash or accrual budgeting hereon.

The members and other stakeholders must receive clear answers to these questions, and the manner in which the so called ‘surplus’ in the ISA was estimated.

Third, in the same inter view, the EPFO Commissioner acknowledged that the 9.5% interest rate for 2010-11 is a one-off event. If this is the case, then why not, as a prudent finance manager would do, declare it as a special additional interest of 1%, outside the normal rate?

Fourth, the EPFO is a regulator of exempted funds. As at March 31, 2009, the investment balances in the exempted funds were `90,100 crore (equivalent to 1.6% of GDP). The EPFO as a regulator has announced that these Funds must also pay 9.5% for 2010-11. This, when it requires them to follow the same outdated investment pattern, with no exposure to equity, as followed by the EPFO.

The EPFO, due to its gross inefficiencies, was able to show a ‘surplus’ in the ISA to pay higher rate. The EPFO is misusing its regulatory power by first not separating one-off interest rate from the normal rate, and then forcing exempted funds to also pay a higher rate.

It is good regulatory practice internationally that a service provider must not be a regulator as well. The current arrangement is like putting the State Bank of India in charge of regulating the banking sector. That the current arrangement has continued for six decades is a strong indication that long-term retirement of the members belonging to the EPFO is not being addressed in a professional manner. The EPFO must be absolved of its responsibility to regulate exempt funds.

Fifth, given the large actuarial deficit in the EPS, if there indeed was a surplus, why was it not used as a reserve against future liabilities of the EPS? The official explanation that EPF and EPS are separate is utterly unconvincing. The EPFO Board has been making changes simultaneously, affecting both; and it also has the same pattern of investments, even though long-term asset-liability positions of the two are very different.

The manner and reason for announcing 9.5% rate for 2010-11 for EPF’s operative accounts is only a symptom of deep malaise of the EPFO as an organisation and those who manage and supervise it. It is time to insist that EPFO be thoroughly revamped and modernised so it can provide quality and quantity of services commensurate with burdens it imposes on the rest of the economy.

The writer is a professor of public policy at the National University of Singapore and can be reached at sppasher@nus.edu.sg. Views are personal.