A large number of people in India have significant amount of money invested in Provident Fund (PF) which forms a critical part of their financial savings towards their retirements. The interest rate applicable for the year is announced by the Labour ministry after their discussion with the Finance ministry.
The interest rate applicable for this year is 8.65%. You may wonder how come this high rate is being given when the overall interest rate in the economy are now sub 7%. The only reason which I can fathom is – the gains accrued by the EPFO out of its investments in Equity Markets.
As per the last published Annual Report for the year 2016-17, as of 31 Mar 2017, approx 21,600 crore of PF money was invested in Equities via ETFs of which investment for one year was approx 15,000 crore. PF authorities can not invest more than 15% of its corpus in Equities.
From the chart below, you may notice :
- From 1950 to 1970, the rate of interest gradually picked up from a low of 3% and climbed up to 5%.
- In next one decade (70-80s), it kept on going up to 8%
- For 15 years (1985-2000), PF enjoyed a double digit rate of approx 12% post which it started peaking and dropped to 9.5%
- From 2005 onwards, it has been on moving within a range of 8.75-8.50%
With lowering G-Sec rates, it will be difficult for the government to maintain 8.50%+ rates in the future, unless the exposure towards Equities is enhanced. However, with increased allocation towards Equities, the yearly volatility of the portfolio returns will be increased.
Passing thought > Who said that Debt returns are guaranteed. To me, even PF rates are like stock market returns, just that the movement happens on a yearly basis rather than daily.