6 Reasons The Proposed EPFO Reforms Make Sense

The Employees Provident Fund Organisation (EPFO) was formed In India in the 1950s, a time when the policymakers had limited understanding of the financial markets and the economics of pension funds. Besides, in the body's early days, labour unions exercised an unusually high influence on how the EPFO was run.

However, the times have changed, and today, with more participation in financial markets and their instruments, equities could prove a good bet for employees to earn better returns. Economists have for long been pointing out that employees could earn higher yields from their investments if they put their money in equities, instead of depositing part of their salary in the employees' provident fund.

The trustees of the EPFO have only recently agreed to consider allowing subscribers to pledge their future PF contributions to buy low-cost homes. If this materialises, the employees' provident fund contributions would be seen as their EMI (equated monthly instalment) payments. Will this make low-cost apartments in India accessible to more people? And is this important? If so, why?

Here are a few reasons that put things in perspective:

• Employees have little choice in determining the portion of their salary that is deposited in the employees' provident fund (EPF). They are not allowed to choose their fund managers, either. This might not be a democratic way of nudging households to save more.

• Historically, equity index funds have outperformed bonds. Even though no asset class has performed as well as equities, the EPFO corpus is often invested in low-yield bonds. Though a fraction of the money deposited in employees' PF is invested in private bonds, regulations prevent a greater share in these instruments.

• Many households invest in gold and real estate because the yields on government bonds are low. By facilitating investment in residential real estate in India, the EPFO could raise the yield from investment of employees' PF.

• Inflation has eroded the value of household savings in India. Since Independence, inflation in the country has rarely been below five per cent —the trend has been changing in the past few months, though. When inflation is high, depositing a portion of employees' salary in EPF makes little sense.

• A large part of subsidies to the EPFO goes to a small fraction of its subscribers. These subscribers, often, are relatively affluent ones. Allowing people to pay EMIs for low-cost homes — if the plan is implemented well — will be a major reform.

• Employees should be given the option of choosing from among a broad range of asset classes to invest in. People are likely to make the right choices only when they are free to do so. Currently, many are likely to pay rent, while simultaneously depositing in the employees provident fund. The planned reforms might change the picture for better.