While lowering the interest rate on the employee provident fund can help them reduce the financial burden, there are obvious social concerns.

Omkar Goswami, Chief Economist, CII

There are two reasons for cutting the EPF rate which, in real terms, is around 5.5 to 6 per cent today -- 9.5 per cent nominal minus a 3.3 per cent inflation in 2002-2003. And since this 9.5 per cent interest is tax-free, the actual interest is around 11 to 12 per cent.

The first reason has to do with the macro-economic aspects of the economy, particularly, the financial sector. The other has to do with the returns earned by people who contribute to the EPF.

Given the political nature of the debate, it is more useful to take the second aspect first. What we are hearing across the length and breadth of the country, from salary earners, is that the government cannot and must not shrink their savings because they have loyally paid taxes, which is something many manufacturers and no farmer has done.

Why then, we're told, should the government be so churlish and take away returns that they earn in their old age, especially in a country without adequate provisions for a safety net?

It is important to answer this question with international data. The experience of OECD (Organisation for Economic Cooperation and Development) countries as well as some of the developing countries that have provident funds and social security schemes, clearly shows that over a long period, fixed income funds rarely earn a real rate of return of over 4 to 4.5 per cent. By its very nature, a pension fund would have a large fixed-income earning component.

Countries that have consistently paid higher interest than this have done so by creating distortions in the system that have eventually boomeranged on the economy and the financial sector.

In the last two decades, the prime example of this is Japan, where postal savings rates were kept far too high, partly to encourage savings and partly to ensure pensioners were taken care of. Today these rates could not be sustained, and the Japanese financial system is a mess.

Is a real return of 4.5 to 5 per cent fair? I would argue that it is, because what it is telling you is that, by and large, year on year, your provident fund will earn you up to 5 per cent above the inflation rate.

That will not only protect you against the vagaries of price rises, but will also give you an extra 5 per cent per year. Today's EPF rate is 9.5 per cent, and while inflation rates go up and down, the average for the year in 2002-03, was 3.3 per cent. So, the real return was 5.7 per cent.

Now, it is important to answer the first question, which is what would a high real return of 6 to 7 per cent do to the economy and the financial sector. First, it makes interest rates sticky. No bank or financial institution that is taking money from depositors is willing to lower rates for fear of household savings moving to provident funds and other small saving schemes.

This is what happened in India over the past few years, especially since the interest on small savings instruments like provident funds is not just 9.5 per cent -- taking the tax-breaks into account, it's actually 11 to 12 per cent.

Second, the high real rate of interest creates a fantastic source of funds for the government to fund its profligacy. At the end of the day, after all, where can provident funds invest? According to our PF laws, funds can invest only in government securities, state government paper, and public sector bond/debt.

So, what high interest rates on small savings do is to create a big opportunity for governments to consistently spend more than what they can earn. It is a costly deficit financing measure.

Today, with the average yield on a 10-year treasury bond just around 5.8 per cent, imagine an EPF manager's plight --his liability is 9.5 per cent, but the yield he gets is under 6 per cent. So how do you fund the gap? The only way out is a Ponzi.

Pay the first person whose PF is due from the amounts paid by those still in the scheme. This, by the way, has been done before, in the case of US64. You cannot have a situation, in the long-run, where the asset-liability yield difference is more than 320 basis points, and rising.

Sahib Singh Verma, Union Labour Minister, Government of India

"I am determined to ensure the interest rate on employees provident fund does not go below the current 9.5 per cent interest we are paying. I also want to ensure a system by which in the future, too, interests rates on EPF do not go down and are kept steady.

There are a number of reasons for this. If there is one social security scheme of the government that has never attracted any scam or questioning, and has worked with efficiency, and represents the life savings of the working class, it is EPF.

We have tried to make it more efficient by full-scale computerisation, issuing smartcards and the like, so that the concept of EPF representing security, permeates deep into the minds of people.

Because the EPF represents comprehensive social security, I think it should be de-linked from the so-called interest rate regime that applies to the government's commercial activity. People have their money in pension funds. If the government reduces interest rates, how will we retain a steady interest rate on this fund?

Our view is slightly different. We believe that whatever we get is money that belongs to workers. We are honour-bound to redistribute it to the workers. This should be unaffected by the government's other economic commitments.

There is another factor. During this budget, the government announced that it would pay a 9 per cent interest to those who were above the age of 55 and had deposited Rs 200,000 or above in the pension fund.

If the interest rate regime does not permit higher rates of interest, how was this achieved? Why can't the same return be given to EPF? A person who can afford to pay a deposit of Rs 200,000 is not a poor man. EPF subscribers are people belonging to the middle and lower-middle income group. We need to take care of such people.

Because we don't want to cut interest rates, we are studying other options to more gainfully deploy the corpus that is available to us. One option is to turn the EPF organisation into a bank that will earn money through banking operations. Obviously, this will need the concurrence of the finance ministry.

Investing money in the market or schemes, other than the Special Deposit Schemes where 80 per cent of our money is currently invested, is not a viable option because it is not safe.

But we can give loans to government organisations from our corpus at a rate of return higher than the yield on SDS. The Delhi Municipal Corporation has offered us a return of 10 per cent on a loan that they want. It is a Central government body.

I had made another suggestion to the finance ministry. We told them we could lower the rate of interest if the finance ministry gave us a guarantee that it would pay the difference. But that didn't work out.

Everyone has to understand that EPF is a fund meant for people to sustain themselves in the evening of their lives. Basically PF represents savings for old age.

If 9 per cent interest can be offered to pension fund subscribers above the age of 55, who have deposited Rs 200,000, why deprive EPF subscribers who have become members of a fund for the same reason -- security in old age?

I am quite clear that if I can help it, I will not reduce EPF interest rates. We are responsible for social security and merely acceding to the logic that there is a flexible interest regime so EPF funds must also be subservient to this, is not the correct way to look at the problem.

Salaried people must be protected, not just now, but for all time to come. Just as the pension fund will pay depositors above a certain age 9 per cent interest irrespective of whether the interest rate regime is 2 per cent or 5 per cent, we will have to ensure such a system for EPF as well. It is politically necessary.

As told to Sunil Jain and Aditi Phadnis