EPFO in a jam: Why meaningful pension reforms are not moving ahead

Instead of reforms, in many ways, 2022 is showing signs of walk back on pension reforms

Over two decades ago, a finance minister had made the case for the Employees Provident Fund Organisation (EPFO) to tap the markets a bit more to generate higher returns for subscribers. That speech, comma, full stop et al can be repeated even now, 23 years later.

“Pension funds investing in domestic equity markets would help lower volatility in equity markets and as that comes down the cost of capital on the equity side for businesses would come down. We are trying to ensure that we stabilise and smoothen out our equity market,” said Yashwant Sinha. The pith of that appeal remains valid for EPFO as its Central Board of Trustees (CBT), its governing board, sits down this week to decide if India’s largest pension fund should invest 20 per cent of its investment corpus into equities and related funds. The EPFO can already invest up to 15 per cent in the stream, but it rarely does.

For a perspective, consider this: foreign portfolio investors have this year pulled out over Rs 2 trillion from Indian stocks. If the EPFO were to use its financial firepower, that would fill the breach with a matching investment of Rs 38,000 crore. Returns from the market, will allow the EPFO to offer a better return for its investors and burden the tax payers less to subsidise those returns.

Such an investment would not be charity. In ten years since 2010, the equity market has generated a return of over 10 per cent (Nifty Total Returns Index data begins from June 2009). That is the reason why pension funds globally, including a sizable number from abroad are invested in the Indian markets.

Walk back on reforms

Instead of reforms, 2022 is showing signs of walk back on pension reforms. Rajasthan is discontinuing contributions to the New Pension Scheme for its employees to revive an older scheme that elsewhere has almost bankrupted other state governments.

EPFO’s Finance Audit and Investment Committee (FAIC), an advisory group, has recommended raising the investment limit in stock markets of the incremental corpus of the fund to 20 per cent. The vote on the recommendation could go either way.

Sinha’s exhortation 23 years ago may not make much headway with the EPFO board, where the most active members are from labour unions. Sinha, who was a minister in the BJP-led National Democratic Alliance government, told the Board to invest at least 5 per cent in stock markets. The contents of his speech could be repeated this year though, without any change. 

Reforms in the EPFO’s investment structure have hardly moved. Of the EPFO’s incremental corpus, the CBT since 1999 has allowed money to be invested only in equity markets up to a ceiling of 15 per cent and that is it. The headroom has stayed unused.

To guide its investment managers, the CBT has a range. For instance, they can invest 45 per cent to 50 per cent of incremental deposits in government securities. This space is always used up. Investment managers have an operative range of 35 to 45 per cent in other debt instruments, including 5 per cent in short-term ones. Similarly, there is a range of 5 to 15 per cent for investments in equities. The finance ministry proposes an investment scheme every year but it is up to the labour ministry (read CBT) to accept it. In 1999, the EPFO agreed to put its money in equities for the first time. The argument then, and now, is that returns from the equity market are volatile and will hurt the financial security of the workers. EPFO essentially acts as a giant lobby group within the government to “safeguard” workers' interests.

The pension fund, therefore, continues to be essentially a government-funded scheme, even as the centre and states push their employees to opt for a market-related pension plan. As there wasn’t that much government debt for the EPFO to buy and yet leave some for the banks and insurance companies, the centre for decades financed the organisation through a synthetic debt: the Special Deposit Scheme. In effect, the general population was asked to pay a tax to finance the payout to EPF subscribers. The EPF’s investment pattern makes it the only significant pension fund globally that essentially runs on government subsidy.

EPFO was established by the EPF and Miscellaneous Provisions Act, 1952 to offer a contributory provident fund, a pension and an insurance scheme for the workers in the organized sector. It began with offering a 3 per cent rate of interest but soon political leaders began to see the electoral value of offering a higher rate of interest. By FY64 it was 4 per cent and a decade later 50 per cent higher at 6 per cent. The rate peaked at 12 per cent by FY90 to remain there for a decade till Sinha took the politically in-advised step of cutting it back to 9.5 per cent by FY02. The blowback was electorally harsh, as his party realised. (Sinha has left the BJP since then.)

Manmohan Singh, as Prime Minister,  read the tea leaves well and pushed it back up to 9.5 per cent from the 9.1 per cent where the NDA government left office with. Singh cut the rates again to 8.5 per cent next year, but as political clouds got stormy in FY11, went back to 9.5 per cent. A bold move to clip the rates to 8.3 per cent next year was again hastily abandoned. When the UPA government went out of office, the rate was again 8.8 per cent.

The present government has been more circumspect, cutting rates by only 100 basis points at a time till FY21 to reach 8.5 percent. For FY22, the rate has been clipped to 8.1 percent. The last time EPFO was here was FY79, when annual inflation was running at over 17 percent.

Not surprisingly, the CBT again wants the wheels to be rolled back. This year it has asked for more headroom to invest in government papers at the cost of investment in papers issued by public and private sector units or even public sector banks. It wants the minimum investment it must make in these instruments to be halved to 10 per cent from the current 20 of its annual incremental deposits. Instead, the money should be parked in central government securities.

The power play of CBT has stalled meaningful reforms for a decade. According to a Parliamentary standing committee report on finance (of 2019), pension is a luxury available to only 7.4 per cent of the working age population in India. That compares with 65 per cent for Germany and 31 per cent for Brazil, another major emerging market economy.