The Hindu Business Line : PF rate: Pragmatism should prevail

The Central Board of Trustees of the Employee's Provident Fund Organisation has to make a choice between a guaranteed return of 9.5 per cent and an inflation-linked rate of return. The latter would be the right choice, as it can set off virtuous cycles of self-adjusting and affordable interest rates. The latter produce a raft of benefits including better fiscal management, rising investments in public infrastructure and welfare, significant investments by the private sector and better standards of living for households, says G. Ramachandran.

"The poor want jobs for their children: we shall ensure that through higher investments, and through targeted intervention, jobs are available to them. I am convinced that, in the larger interests of the country, we should maintain a benign interest rate regime that appropriately balances the legitimate claims of the savers and borrowers."

— The India's Finance Minister, Mr P. Chidambaram, in his Budget speech

JOBS AND all manner of sources of incomes for the poor and their children are paramount. And, there are few tasks more important and of bigger concern than the tasks pertinent to employment and self-employment generation in India. Without investments of a large magnitude and at benign interest rates, the stakes of the poor would be undermined.

In such circumstances, it would be patently inappropriate to have any targeted intervention in the context of interest rates that turns into a determined wager against the stakes of the poor. Moreover, any intervention in the interest-rate economy should reaffirm the Common Minimum Programme's commitment to the poor. The only possible course for intervention lies in making interest rates serve the joint objectives of savers and borrowers.

First, borrowers have to afford to pay such interest rates that are desired by savers. If borrowers cannot afford the rates demanded by savers, investments would decline. Jobs and incomes will decline as a consequence. Output of goods and services will decline too. That may stoke consumer-price inflation.

Second, savers should afford to postpone consumption and make investments in physical and intellectual assets. Else, they would be unwilling to save. Investments would decline, and this would set off a vicious cycle of falling output, unemployment and declining wages. But India cannot afford vicious cycles anymore. The economy needs virtuous cycles. In a virtuous cycle, interest rates will serve the joint objectives of savers and borrowers. Borrowers should afford to pay interest rates that are desired by savers. Investments will then rise. Jobs, incomes and output will rise as a consequence. More significantly, rising output will hold down the real prices of common goods and services consumed by ordinary people. Therefore, savers will afford to channel their savings into physical and intellectual assets. Investments, employment and wages will rise. The two critical links in the virtuous cycle are rising output and falling or stable prices.

From such a perspective, India's trade unions have the power to choose between a vicious cycle and a virtuous cycle. They would be wagering against the social and economic interests of the poor if they were to hold on to their demand for a minimum rate of return of 9.5 per cent on savings channelled by employees into the employee's provident fund (PF). By contrast, the trade unions would show they are betting on bigger and very pragmatic stakes if they choose to link the PF rate to inflation and the economy-wide real rate of growth achieved.

Choice from within

Members of the Central Board of Trustees (CBT) of the Employee's Provident Fund Organisation (EPFO) will meet today to exercise their choice. They will have to choose between a guaranteed return of 9.5 per cent on savings channelled into PF and an inflation-linked rate (ILR) of return on PF. The latter would be the right choice, and there is earnest hope that the trade unions would choose the inflation-indexed formula.

Mr W. R. Varadarajan, a CBT member and Secretary of the Centre for Indian Trade Unions (CITU), is aware that returns on PF in many countries are indexed to inflation. Mr Varadarajan is also favourably disposed to the idea of an inflation-indexed real rate of return of PF deposits.

What is most comforting at this juncture is that the ILR formula has been proposed by the trade unions (Business Line, July 11). This pragmatic proposal is from within the fraternity and sorority of organised labour. Therefore, the chances that the labour leaders, who are members of the CBT of the EPFO, would accept the new ILR formula are bright.

Moreover, the choice of ILR would obviate the necessity to segregate members — PF savers — into two groups with two differential rates. It would make it unnecessary to set a monthly gross income ceiling for the EPFO. The Employee Provident Fund Act compulsorily covers those who earn up to Rs 6,500 a month. PF savings are voluntary for others.

The ILR will protect the interests of those that earn below Rs 6,500 and others as well. There would be more `authentic engagement' across the economy and more savings that show up as investments, output, jobs, incomes and falling prices.

Win-win virtuous cycle

It is true that organised labour in other economies has chosen to work with returns on PF that are indexed to inflation. Nevertheless, it is important that the motivation for their choice should be understood after a careful scrutiny: Inflation-indexed real rates of return of savings in PF set off virtuous cycles of self-adjusting and affordable interest rates.

Affordable interest rates produce a raft of favourable benefits within the macroeconomy. The benefits of affordable interest rates flow into better fiscal management, rising investments in public infrastructure and welfare, significant investments by the private sector and better standards of living for households.

Quite clearly, affordable interest rates to borrowers and savers set off win-win dynamics across the board. The affordability has an impact on how governments meet their social obligations and imperatives of national defence. The affordability has an impact on how households build their lifetime savings and assets through certainty of employment and incomes.

Organised labour, unorganised labour and the self-employed have derived the most from these benefits. In their productive working lives, they have certainty of employment and incomes. They have access to affordable goods and services. In their retirement, they continue to have access to affordable goods and services while their savings fund their consumption.

Banishing old-age poverty

Most important, ILR and the economy-wide affordability of interest rates ensure that retirees will afford a standard of living that they get accustomed to in their working lives. This is very important since the principal purpose of PF is to enable retirees to afford such a standard of living. When retirees cannot afford such living, old-age poverty sets in. Old-age poverty is the result of diminished purchasing power and rising prices of consumption goods.

ILR is the best antidote to old-age poverty. Half the population of India — 546 million in a country of 1,012 million in 2001 — is below 25 years age. India is a young country that can press millions of talented and skilled youth into the workforce. When they can be pressed into the workforce, output will rise. While they will benefit from their own jobs and incomes, they will set off positive benefits to retirees.

The young in India constitute a very large consumption base for a very wide range of consumption goods. When output rises to meet their massive consumption needs, the marginal cost of producing goods and services for the old and the retired falls.

When the marginal cost of producing goods and services for the old and the retired falls, the affordability of such goods to the old and the retired rises. This is the only known way in which societies take care of their old and the retired. There are no shortcuts because shortcuts are costly and difficult to sustain.

However, if interest rates are very high, the massive investments will not take place. Marginal costs will not fall. The purchasing power of the old and the retired will not rise. They may have PF investments that earn high rates of return, but high marginal costs of consumption goods will eat into their nominally high interest earnings. Therefore, nominal PF rates may do little to make old age affordable and liveable. High nominal PF rates may actually lead to old-age poverty. Too bad!

A new dawn for all

When PF rates are high, the economy-wide interest rate will be high too. Why? Provident funds constitute a single major source of contractual savings by individuals and as a composite constitute a significant value - a stock of Rs 1,50,000 crore and an annual flow of Rs 25,000 crore.

The rate at which this money is contracted signals the rate at which savers are willing to postpone consumption and save for the future by making investments.

Moreover, PF rates are secular. Unlike bank deposit rates that are determined by creditworthiness of individual banks, PF rates are not linked to creditworthiness of any institution. Perhaps, they are linked to the fiscal viability of the government and the creditworthiness of the nation as a whole.

Fiscal viability rises when inflation is low and when government can afford investments in public infrastructure and welfare. The nation's creditworthiness rises when the economy grows. The two point to how inflation and the real rate of growth can be combined to herald ILR. The young and the old will cheer the emergence of ILR for PF savings. It would be a new and happy dawn for all.

(The author is a financial analyst. Feedback may be sent to indiagrow@yahoo.com)

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