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EPF conundrum

CORPORATES AND MARKETS may not be tickled by the one percentage drop in interest rates on Employees Provident Fund (EPF) deposits to 11 per cent as the corpus of around Rs. 45,000 crores goes to service the current expenditure of the Centre. There could be some consolation in New Delhi's apparent earnestness to hold interest rates at current levels, if not attempt the impossible of dropping them. With returns on EPF deposits falling to 11 per cent, no way could the Finance Ministry back the promise of the Central Board of Trustees of the EPF Organisation to pay out 12 per cent.

At the reduced levels, the nominal interest rates on `other liabilities', such as small savings, provident funds and special deposits, seem to be out of line with the general price of money in the economy and when special tax rebates under Sections 88 an d 80L of the Income-Tax Act are woven in, implicit costs could be higher than market borrowings by the Centre. In 1998-99, resource mobilisation through small-savings, provident funds and special deposits rose to Rs. 43,588 crores from Rs. 33,360 crores in 1997-98, forming 42 per cent of the fiscal deficit against 37.5 per cent the previous year. Perhaps, there is a case for making the EPF scheme voluntary apart from broad-basing fund deployment to earn better returns as suggested by a government commit tee; contrarily, market players could play around with funds to threaten monies garnered from employees.

Inside the RBI, one view is that ``it is not market borrowing, but the absence of market borrowing due to guaranteed interest rates on provident fund and small savings that has been responsible for the potential instability of this component of total deb t.'' A recent RBI study, ``Bond Financing and Debt Stability'' (by Vivek Moorthy, Bhupal Singh and Sarat Chandra Dhal) finds that effective returns could be in excess of nominal GDP growth and in 1997-98, the yield at 12.15 per cent exceeded nominal GDP growth of 10.90 per cent. For economists, interest rate changes have to honour the Domar condition which stipulates that GDP growth must exceed interest rates. Is the Indian economy playing true to this rule? From interest rate data, the RBI study thinks there is no evidence of a systematic shift to an unstable debt regime during the 1990s. Importantly, market funding of government debt has trimmed the cost of funds for the private sector. In 1984-85, the weighted average lending rate of banks was 15 pe r cent with a 500-basis-point spread over the weighted interest rate on market loans (over one year maturity). In 1990-91 the spread remained the same but by 1997-98 it had shrunk to under 300 basis points with a dip in lending rates. The study mentions that ``it is quite noteworthy that not just the spread, but all private sector interest rates have declined since the onset of liberalisation.''

Government appetite for funds has not elbowed out corporate needs. Linked perhaps to this detail is the surge in private capital formation since 1990-91 with the capital stock of the private corporate sector now being almost seven times higher than in 19 89-90. Private investment is replacing public efforts and, being more efficient, is pushing up growth. Is it possible for the Government to give up on guaranteed returns (apart from tax benefits) on compulsory savings? If mutual funds cannot guarantee re turns, should government be in the business of making promises? If government can shun its addiction, interest rates could slide further, even in the current milieu, and help fuel double-digit growth.