EPF Rate Plummets To Near All-time Lows

The EPFO announced the interest rate on deposits for FY ’22 on Saturday – and it came in at a near all time low of 8.1% - a sharp 40 bps drop from last year’s rate of 8.5%. Incidentally, this is near the all-time low rate of 8% that was announced 44 years ago in FY ’78.

The “low” rate for the fiscal can be attributed to the accommodative stance that the RBI has maintained since the pandemic struck; holding repo rates at an all time low of 4% for an extended period of time despite burgeoning inflationary concerns and skyrocketing crude oil prices.

Low rates, while great for stimulating consumption by bringing down interest rates, also lowers the coupon on interest bearing securities like Fixed Deposits and Government Schemes.

The EPFO’s official statement was that “in determining the rate of interest, the Central Government shall satisfy itself that there is no overdrawal on the Interest Account as a result of debit thereto of the interest credited to the accounts of members”

Translating that to simple terms; EPFO has a mandate that it won’t ever borrow moneys to pay interest to its investors! That’s a smart rule to be following.

It is also worth noting that despite the steady fall in rates since FY ’19, EPF rates are still far superior that other comparable government schemes – a good 100 bps higher than PPF rates.

This higher return can be attributed to the fact that since 2015, the EPF has been investing a portion of its portfolio into equities – namely, ETF’s and CPSE companies. In the last fiscal, the EPFO’s equity portfolio (which is incidentally almost 3X the size of the entire mutual fund industry at 1.23 lakh crores) returned an impressive 14.6% per annum.

Given that EPF rates are tax free (for now), post tax returns from the EPF are at par with conservative hybrid funds, that maintain a similar asset allocation. These funds have returns between 7-9% on an annualized basis over the past 5 years. That’s quite a feat for a portfolio that is neither very actively managed nor run by “star” fund managers!

The bigger question to ask yourself is: should you be satisfied with a ~PPF+75bps return on your long-term retirement savings that could span anything from 20-30 years? In that sort of timeframe, the return from SIP’s in aggressive equity funds could be significantly higher (albeit not linear). The opportunity cost of not taking risks in such a long-term horizon is too high to ignore. 

Smart investors should consider looking beyond the EPF - and understanding how investing systematically in risk assets over long timeframes can help them create an exponentially higher retirement corpus than the EPF ever could.