NEW DELHI, India -- A government-appointed committee has proposed liberalizing investment of the 2.65 trillion crore rupee ($62.5 billion) Employees' Pension and Provident Fund, potentially sending a wave of new money cascading into Indian capital markets.
If adopted, changes could mark the fund's first move into equities, and triple the fund's investments in domestic non-governmental securities, pushing some $12.5 billion into Indian capital markets.
Interest changes
Meanwhile, Indian government sources said, the Reserve Bank of India is considering free floating the now fixed interest rate credited to participants in the Provident Fund, which covers all state and private workers in companies with more than 20 employees.
At present, the Provident Fund credits participants with a 12% interest rate, among the highest in the world. But the cost is driving up the center coalition government's budget deficit, projected to be $22.5 billion for the current financial year.
Easing investment restrictions on the fund could help improve returns at the provident fund, which has earned as little as 2.5% a year, according to a Feb. 18 report by the Dave Committee.
Named after Sudhir Dave, chairman of the government's committee on pension fund reforms and a former chairman of Unit Trust of India, the report proposed allowing the provident fund to invest 20% of assets in investment-grade corporate debt and 10% of assets in domestic stocks. While the law now allows the fund to invest 10% of assets in domestic non-governmental securities, in reality the fund has no stock investments. If adopted, the proposal could give a strong boost to both corporate debt and stock markets.
The Provident Fund also is required to invest a minimum of 40% of assets in state-owned companies and 25% in central government securities. Investment outside of India is not permitted.
Potential gains
Explained former Finance Secretary Montek Singh Ahluwalia: "If a small percentage of the trillions of dollars of pension funds come to the Indian capital market, it will give a tremendous boost to the cash-starved corporate sector."
Initially, investments in domestic equities should be permitted only through externally managed index funds.
However, the proposal faces strong opposition from left-wing politicians and union leaders who worry about short-term volatility of the stock market.
Gurudas Dasgupta, a leader of India's Communist Party and a member of Parliament, said, "In no way should public pension money be put in speculative markets."
Numerous Indian companies that went public during India's 1992 to 1994 boom years subsequently collapsed, making politicians chary of any stock market investments.
Varada Reddy, one of 24 members of the Provident Fund's Central Board of Trustees and leader of the Center of Indian Trade Unions, New Delhi, agreed exposure to the Indian stock market is too risky.
But that's why the Dave Committee would restrict equity investments to the largest-cap stocks.
When releasing the report, Mr. Dave said long-term returns on equities around the world are good despite short-term volatility.
"Investment should be permitted only in those equities where market capitalization is high, and liquidity is also high," he said.
Meanwhile, government officials also are working behind the scenes to cut the government's huge pension costs.
The statutory 12% annual credit is adding to an already growing budget deficit, now about 6% of India's gross domestic product.
The problem is that the rate is fixed, while yields are falling. The Reserve Bank cut rates by one percentage point, to 10%, in January, making it tougher for fund managers to bridge the gap through investments.
Other attempts to cut political subsidies met with strong resistance, and the government had to back down.
Now, Finance Ministry officials think pegging interest rates to an unidentified benchmark might save the government money, abandoning the present procedure of offering 12% interest on the daily closing balance.
This would avoid a direct cut in interest rates, which could generate public outcry. A proposal is expected to be issued by the end of March.
