Revisiting the EPF rollback

If the EPF tax had not been rolled back, it would have forced distress sales of government securities.

Finance Minister Arun Jaitley’s Budget 2015-16 promised to set up a Public Debt Management Agency to bring the government’s external borrowings and domestic debt under one roof. While the government claims to be committed to creating such an office, in April 2015, while introducing official amendments to the Finance Bill, it withdrew the minister’s promise. A Debt Management Office was first announced in the 2007-08 Budget, but the idea has been floating between the corridors of North Block and Mint Street since. 

On March 7, Mr. Jaitley also informed Parliament that two paragraphs from his 2016-17 Budget speech — that sought to nudge the working class into reconsidering their preference for the employees’ provident fund (EPF) as a retirement saving tool — stand deleted. Multiple theories were floated by the Finance Ministry to justify the proposal to tax EPF savings prior to this, such as the need to promote the national pension system (NPS) set up by the Ministry and deprive the well-off from milking tax breaks. 

The revenue expected from the tax on EPF savings was just around Rs. 200-300 crore. The larger system-wide implications of the move would have, perhaps, been better thought through had a public debt office been in place and consulted on the proposal. It is unlikely the Middle Office (Debt Management), set up in the Department of Economic Affairs (DEA) in 2008 to facilitate the transition to a full-fledged debt office, had a chance to comment. The Middle Office is tasked with formulating strategies for sustainable long-term debt management. And it is precisely here that the plan to tax 60 per cent of EPF savings could have had profound implications on the Centre’s borrowing programme in the years to come.

Cheaper and longer
The DEA has issued the government’s tentative borrowing programme for the first half of 2016-17, according to which it will raise Rs. 3.55 lakh crore of the total annual borrowing target of Rs. 6 lakh crore. Economic Affairs Secretary Shaktikanta Das said less than a fifth of this would be raised through securities maturing in less than five years. The government would prefer to raise more cash through longer-term securities — anything between Rs. 2.64 lakh crore to Rs. 3.36 lakh crore could be raised via bonds with tenures of ten years or more. The calendar is meant to enable investors ‘to plan their investment efficiently and provide stability’ to the government securities market. 

Two hours later, the Ministry notified a new regime of quarterly interest rates on small savings instruments, including the Public Provident Fund, Kisan Vikas Patra and post office savings deposits. The sharpest reduction in returns is on one year time deposits with post offices, which will now earn 7.1 per cent as opposed to 8.4 per cent. This would narrow the gap between returns on one year bank deposits and the competing post office scheme to just 0.35 per cent as opposed to 0.95 per cent at present. 

Mr. Jaitley has firmly and rightly defended the move, as high small savings rates make it difficult for banks that compete with them for deposits to lower their lending rates and effectively distort the transmission of monetary policy changes effected by the Central Bank on the ground. The RBI has, for instance, cut one of its benchmark rates (repo rate) by 125 basis points since January 2015, but this hasn’t been passed through by banks. 

While industry feels lower interest rates will spur a revival in investments, more immediate relief will come from lower debt servicing burdens for India’s large infrastructure and heavy industry players that are over-leveraged and messing up bank balance sheets. Lower rates would also help the largest borrower — the government — whose interest liabilities on outstanding debt would rise by an estimated Rs. 50,000 crore in 2016-17 from Rs 4.43 lakh crore this year. 

Nomura analysts Sonal Varma and Neha Saraf said in a note on March 21 that the small savings rate cuts would pave the way for greater monetary policy transmission (read lower rates). “With small savings schemes offering much higher interest rates relative to bank deposits, their collections have also risen to a ten-year high in 2015-16… lower small savings rates portend a fall in small savings collections,” they said, but added these lower inflows would mean “greater reliance on market borrowings by the government”. 

Over the past six months, the government had signalled its intent to lower small savings rates and bring them closer to market-determined rates for its own borrowings over comparable tenures in “the interest of overall economic growth of the country”. This is probably why the outcry over small savings rate cuts was sharp, but short-lived. Plausibly, a similar building up of the case to bring parity in tax treatment for retirement schemes like EPF and NPS could have blunted the outcry over the EPF tax proposal. 

Consider this: among the big buyers for government securities are banks, insurers including the Life Insurance Corporation of India (LIC), mutual funds, and foreign portfolio investors. But few have asset-liability profiles that require them to invest as much in long-term debt that the government would like. Some global pension funds have what debt market dealers call a “sticky” appetite for such bonds. But their entry and exit is unpredictable, like that of other entities with active treasury desks trading their holdings according to price and yield movements. 

Captive debt financier
By contrast, India’s largest retirement fund, the Employees’ Provident Fund Organisation, with oversight over Rs. 10 lakh crore, is a captive financier of government debt thanks to investment norms set by the Finance Ministry and has the appetite for longer term debt. In 2015-16, it will invest up to 65 per cent of its rising inflows or Rs. 74,500 crore into government securities (g-secs). And unlike other entities, including the NPS, the EPF holds securities till they mature.

The Finance Ministry prodded the EPFO to invest in equities for years so that it acts as a stabilising force against fickle foreign investment flows and EPF savings have made a modest foray into Dalal Street this year. It is unusual that the role of EPFO, and the 3,000-odd company-run PF trusts under its watch, in the g-secs market wasn’t considered similarly. 

LIC is a buyer of last resort in disinvestment. The EPF, on the other hand, is a buyer of g-secs with no resort and it doesn’t trade, except when its payouts exceed inflows. In the week after the Budget, HR managers fielded frantic calls from employees urgently seeking to withdraw their EPF balances and stop fresh voluntary contributions from April 1. If the EPF tax had not been rolled back, it would have forced distress sales of g-secs and shut the tap on higher inflows that would have automatically financed fresh public debt. 

The Finance Ministry has termed EPF members as hostages that must be freed and questioned the ‘subsidy’ to its members. It may have ended up paying more for its borrowings if it had succeeded. That is, if the idea would have passed muster with a functional Debt Management Office. 

Source :  http://www.thehindu.com