All You Wanted to Know About Restriction on EPF Withdrawal

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This is one of the changes that I should have written about at least five-six weeks back, but somehow I did not. Nevertheless, given the long term impact of this change, it’s still not very late to discuss it.

From February 10, 2016, onwards, the government has restricted the total amount of money that any contributor to the Employees’ Provident Fund can withdraw. As the government notification points out: “The Central Board, or where so authorised by the Central Board, the Commissioner, or any officer subordinate to him, may on an application made by a member in such form as may be specified, authorise payment to him from his provident fund account not exceeding his own total contribution including interest thereon up to the date the payment has been authorised on ceasing to be an employee in any establishment to which the Act applies.”

The notification further points out: “The member making an application for withdrawal under sub- paragraph (1) shall not be employed in any factory or other establishment, to which the Act applies, for a continuous period of not less than two months immediately preceding the date on which such application is made.

So what does it mean? It basically means that anyone who has been unemployed for two months or more can now withdraw only his own contribution into the Employees’ Provident Fund and the interest that has accumulated on it.

The employer’s contribution and the interest that has accumulated on it thereon, can only be withdrawn at retirement i.e. at the age of 58. The age of retirement has also been increased from 55 to 58.

This change does not apply to “female members resigning from the services of the establishment for the purpose of getting married or on account of pregnancy or child birth.”

Earlier the entire corpus that had been accumulated under the EPF could be withdrawn. And if the corpus had accumulated for five years or more, it was even tax-free.

This was a loophole used by many individuals to withdraw their entire accumulated EPF corpus at the point they changed their jobs. All it needed was a declaration that they were unemployed. The Employees’ Provident Find Organisation(EPFO) had no way of verifying this.

Of course, the move by the government to clamp down on total withdrawal of EPF, comes on account of individuals withdrawing their entire EPF corpus when they changed their jobs. This withdrawal led to people not building a good retirement corpus. If viewed from this angle, this is a good move.

It will help individuals build a good retirement corpus. Also, with only partial withdrawal allowed, it will encourage individuals to transfer their EPF accounts when they change jobs, instead of simply declaring that they are unemployed and withdrawing their contribution to the corpus.

Anyone who understands the power of compounding will know that this is a good move, given that as the corpus grows the compounding has a greater impact. An interest of 8% on Rs 1 lakh amounts to Rs 8,000. But the same interest on Rs 5 lakh amounts to Rs 40,000. A bigger corpus in case of EPF is only possible when employees transfer their EPF accounts when they move jobs.

Also, what happens to people who are actually unemployed and can only withdraw the employer’s contribution to the EPF and the interest accumulated on it, only after the age of 58?

In fact, as I write this, the EPFO has made a decision to give interest on inoperative EPF accounts. These are essentially accounts in which no contribution has been made by the employee or the employer for a period of 36 months. Hence, what this means is that an individual who is facing long-term unemployment and cannot withdraw a part of his EPF corpus, will continue to earn interest on the corpus that he cannot withdraw.

This was not possible earlier. This change had to be made given that if the government does not allow people to withdraw their entire EPF corpus, it should at least be paying interest on the part of the corpus that cannot be withdrawn.

But all this is just one side of the coin. What happens in case of individuals who actually lose their jobs and face long-term unemployment? In this day and age this is possible. Even though they have money in the form of the employer’s contribution to the EPF, and the interest earned on it, they cannot withdraw it.

This may force them to borrow money from money lenders. Hence, it is not fair on them. The trouble is that the EPFO up until now has had no way of verifying if the individual withdrawing the corpus is actually unemployed or is simply changing jobs. This is a weakness at the level of the EPFO.

Given the information technology infrastructure available these days, it shouldn’t be so difficult to figure out whether the individual is actually unemployed or is simply moving jobs. Let’s say the individual withdraws the entire corpus accumulated under EPF and then takes on another job, his permanent account number(PAN) continues to remain the same. So how difficult is it for the EPFO to figure out whether the person has actually changed jobs? Not very.

Other than people facing long-term unemployment, these days some individuals also like to take a break and go back to studying, in order to improve their job prospects. The money that they have accumulated under EPF can help in paying the part of the fee. People going back to studying at the age of 25-30 are really not thinking about retirement, they are thinking about improving their job prospects by studying more. And if they study more, their job prospects are likely to be better in the years to come.

The EPFO needs to be flexible on this front. A better information technology infrastructure can clearly help.

Also, I think we are reaching a stage, where people who are in a position to manage their money, need not depend on EPF. They need to negotiate with their organisations to have a minimal contribution made to their EPF and the remaining money be paid out to them as a part of their normal salaries, which they can then invest in order to save tax as well as accumulate a corpus. It will also ensure that a portion of their corpus is not stuck with the EPFO until the age of 58. Organisations which are looking to retain talent also need to be flexible on this front.

But given how HR departments in organisations work, I clearly don’t see this happening.

The column originally appeared on Vivek Kaul’s Diary on March 31, 2016.

Janet Yellen’s tourist dollars are driving up the Sensex

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Central bankers drive stock markets. At least, that is the way things have been since the current financial crisis started in September 2008, when Lehman Brothers, the fourth largest investment bank on Wall Street went bust.

On March 30, 2016, the BSE Sensex rallied by 438 points or 1.8% to close at 25,338.6 points. What or rather “who” was responsible for this rally? Janet Yellen, the chairperson of the Federal Reserve of the United States, the American central bank.

Yellen gave a speech on March 29. In this speech she said: “I consider it appropriate for the committee to proceed cautiously in adjusting policy.” The committee Yellen was referring to is the Federal Open Market Committee or the FOMC.

The FOMC decides on the federal funds rate. The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans.

In December 2015, the FOMC had raised the federal funds rate for the first time since 2006. The FOMC raised the federal funds rate by 25 basis points (one basis point is one hundredth of a percentage) to be in the range of 0.25-0.5%. Earlier, the federal funds rate had moved in the range of 0-0.25%, for close to a decade. FOMC is a committee within the Federal Reserve which runs the monetary policy of the United States.

The question that everybody in the global financial markets is asking is when will the FOMC raise the federal funds rate, again? It did not do so when it met on March 15-16, earlier this month. The next meeting of the FOMC is scheduled for April 26-27, next month.

By saying what Yellen did in her speech she has essentially ruled out any chances of the FOMC hiking the federal funds rate in April 2016. This is the closest a central bank head can come to saying that she will not raise interest rates any time soon.

This was cheered by the stock markets all over the world. Yellen basically announced that the era of “easy money” was likely to continue, at least for some time more.

This means that financial institutions can continue to borrow money in dollars at low interest rates and invest this money in stock markets and financial markets all around the world, in the hope of earning a higher return.

This means that the “tourist dollars” are likely to continue to be invested into the Indian stock market. Mohamed A El-Erian defines the term tourist dollar in his new book The Only Game in Town. As he writes: “During periods of large capital flows induced by a combination of sluggish advances economies, robust risk appetites, and highly stimulative central bank policies, emerging markets serve as destination for a huge pool of crossover funds, or what I refer to as tourist dollars.

As Erian further writes: “Rather than “pulled” by a relatively deep understanding of country fundamentals, this type of capital is typically “pushed” there by prospects of low returns in their more traditional habitats in the advanced world.”

The federal funds rate in the United States is in the range of 0.25-0.5%. In large parts of Europe as well as in Japan, interest rates are in negative territory. In this scenario, the returns available in these countries are very low. At the same time, it makes tremendous sense for financial institutions to borrow money at low interest rates from large parts of the developed world and invest it in stock markets, where they expect to make some money.

And India is one such market, where these “tourist dollars” are coming in and will continue to come in, if the central banks of the developed world continue running an easy money policy.

What got the stock market wallahs all over the world further excited was something else that Yellen said during the course of her speech. As she said: “Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long term interest rates and so support the economy.”

What does this mean? This basically means that, if required, the Federal Reserve will print money and pump it into the financial system to drive down long-term interest rates in the United States, so that people will borrow and spend more. This was the strategy that the Federal Reserve used when the financial crisis started in September 2008. This basically means that the era of easy money unleashed by the Federal Reserve is likely to continue in the days to come.

Now only if the Modi government could get its act right on the economic front., the tourist dollars would just flood in.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on March 30, 2016

Why RBI Should Not Cut Interest Rate by 1%

 

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In an interesting The Honest Truth column which was recently published, Ajit Dayal writes: “I think the RBI may charge ahead with a 100 basis points cut!” One basis point is one hundredth of a percentage. Hence, 100 basis points amount to 1%.

The Reserve Bank of India(RBI)’s next monetary policy statement is scheduled for April 5, 2016.

Dayal offers multiple reasons on why he thinks the RBI may cut the repo rate by 1%. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark for the short and medium term interest rates in the economy. I would highly recommend that you read Dayal’s column before you start reading mine.

The stock market wallahs always want lower interest rates because they believe that lower interest rates take the stock market to higher levels. The logic is that at lower interest rates people will borrow and spend more. They will buy more two-wheelers, cars, consumer durables and homes, and this will benefit companies. With this increase in consumption, earnings of companies are likely to go up, and the stock prices will adjust for it.

Further, it will also benefit companies which have a huge amount of debt. They will have to pay a lower amount of interest to service their existing debt. Third, the banks will benefit from the huge bond portfolios that they have.

As Dayal writes: “A 1% cut in interest rates would boost the value of the bond portfolios of banks by 10% to 15%. So, for every Rs 100,000 crore of bonds held by the banks, there will be a possible Rs 12,000 crore to Rs 15,000 crore surge in the net worth of the bank.”

Interest rates and bond prices are inversely related. As interest rates fall, bond prices go up. This is because investors want to stock up on bonds issued earlier, which pay a higher interest. This drives up the price of these bonds. As prices go up, this benefits banks which already own these bonds and they make higher profits.

While these reasons make sense, they present only a part of the picture. In this column, the point I will make is exactly the opposite of what Dayal is making i.e. RBI should not cut the repo rate by 1%, or at least not all at once.

There are multiple reasons for the same. First and foremost, the RBI cutting the repo rate is just a part of the process of the overall interest rates coming down. When the RBI cuts the repo rate, the banks need to pass on the cut to their borrowers as well. This happens by the banks cutting their deposit rates as well as their lending rates.

But what has happened in the Indian case is that banks have cut their deposit rates without cutting their lending rates at the same pace. As RBI governor Raghuram Rajan had said in December 2015 “Since the rate reduction cycle that commenced in January [2015], less than half of the cumulative policy repo rate reduction of 125 basis points has been transmitted by banks. The median base lending rate has declined only by 60 basis points.”

So a 100 basis points cut by the RBI will lead to banks cutting the interest rates on their deposits without cutting their lending rates at the same rate. Historically this is what banks have always done and there is no reason to believe that this time will be any different.

And this is not a good thing. Hence, it is best that the RBI cut the repo rate in a gradual way, 25 basis points at a time, wait to see whether the banks pass on the cut and then move further.

A new marginal cost based lending rate comes into the picture for banks from April 1, 2016. The RBI needs to wait to see how this pans out and whether banks actually go about cutting interest rates on their loans, as they are expected to.

Also, many economists and analysts look at interest rates just from the point of view of the borrower. But what about the saver? If the interest rates are cut dramatically the saver will have to save more to meet his or her financial goals, in the years to come. How about taking that into account as well?

Deposits with banks, non-banking companies and cooperative banks and societies, form a major part of household financial savings of Indians. In 2011-2012, 2012-2013 and 2013-2014, deposits formed 58%, 56% and 69% of the total household financial savings. Banks deposits made up for 53%, 50% and 62% of the total household financial savings. (The breakup for 2014-2015 is not available).

Hence, interest rates need to be viewed from the point of view of savers as well, given that a major part of savings are in bank deposits. The economist Michael Pettis makes a very interesting point about the relationship between interest rate and consumption in case of China.

As he writes in The Great Rebalancing: “Most Chinese savings, at least until recently, have been in the form of bank deposits…Chinese households, in other words, should feel richer when the deposit rate rises and poorer when it declines, in which case rising rates should be associated with rising, not declining, consumption.”

Given that a large portion of the Indian household financial savings are invested in bank deposits, any fall in interest rates should make people feel poorer and in the process negatively impact consumption, at least from the point of savers.

Also, people who are savings towards a goal will have to save more. Pettis explains this in his book through an example that one of his students told him about. As he writes: “According to my student, her aunt was planning to save a fixed amount of money for when her twelve-year-old son turned eighteen and was slated to go university. She had a certain amount of money already saved, but not enough, so she needed to add to her savings every month to achieve her target.”

A similar logic applies in the Indian case as well and needs to be taken into account whenever we talk about lower interest rates.

Rajan has often said in the past that he wants to maintain a real interest rate level of 1.5-2%. Real interest is essentially the difference between the rate of interest (in this case the repo rate) and the rate of inflation.

The consumer price inflation on which the RBI bases its monetary policy on, in February 2016, stood at 5.2%. If we add 1.5% to this, we get 6.7%, which is more or less similar to the prevailing repo rate. The current repo rate stands at 6.75%.

The last time I used this argument some readers on the social media pointed out that instead of using the repo rate, I should have used the interest rate on fixed deposits to make this argument.

I used the repo rate because that is what the RBI does. As a February 2016 newsreport of the PTI points out: “Deputy Governor Urjit Patel also defended the RBI move to take into account the repo rate, and not the deposit rates, while computing the real rate of interest, saying the rate set by RBI is a universal one which is relevant for the entire country.”

Nevertheless, let’s take the case of the interest rate that the State Bank of India pays on its fixed deposits for a period of 5-10 years. The interest rate is 7%.

The latest consumer price inflation is 5.2%. If we to add 1.5% to this, we get 6.7%. The SBI interest rate is 7%. Hence, there is a scope for 25 basis point repo rate cut from the RBI, if we use the bank fixed deposit interest rate to calculate the real rate of interest.

The interest rate offered by SBI on a fixed deposit of a tenure two years to less than three years, is 7.5%. If were to consider this while calculating the real rate of interest, then there is a scope for a 75 basis points rate cut by the RBI.

It is important that a real rate of interest of 1.5-2% is maintained in order to drive up the rate of household financial savings. In 2007-2008, the household financial savings had stood at 11.2% of the gross domestic product (GDP). By 2011-2012, they had fallen to 7.4% of GDP. Since then they have risen marginally. In 2014-2015, the household financial savings stood at 7.7% of GDP. This needs to go up.

This column originally appeared on the Vivek Kaul Diary on March 30, 2016

MONEY LESSONS FROM A TORN NOTE

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Over the last two months I have been carrying a slightly torn one hundred rupee note in my pocket. Nobody wants to accept it.

The note is slightly torn on the upper left hand side but the serial number is still visible. This essentially means that there is nothing wrong with the note and it continues to be a legal tender.

As Charles Wheelan writes in Naked Economics—Undressing the Dismal Science: “Consider a bizarre phenomenon in India. Most Indians involved in commerce—shopkeepers, taxi drivers, etc.—will not accept a torn, crumpled, or overly soiled rupee note.”

This entire act of not accepting torn notes doesn’t make any sense. As Wheelan writes: “The whole process is utterly irrational, since the Indian Central Bank [the Reserve Bank of India] considers any note with serial number—torn, dirty, crumbled, or otherwise to be legal tender. Any bank will exchange torn notes for crisp new ones.”

As the Reserve Bank of India points out: “Soiled notes are those which have become dirty and slightly cut…The cut in such notes, should, however, not have passed through the number panels. All these notes can be exchanged at the counters of any public sector bank branch, any currency chest branch of a private sector bank.”

The exchange facility is also available for mutilated notes or notes “which are in pieces and/or of which the essential portions are missing can also be exchanged.”

Given this, why do people still not accept soiled as well as mutilated notes? As Wheelan writes: “Rational people refuse legal tender because they believe that it might not be accepted by someone else…The whole bizarre phenomenon underscores the fact that our faith in paper currency is predicated on the faith that others place in the same paper.”

This is a very interesting point. At the end of the day, paper is money is just paper with some ink on it. A 100-rupee note is ten times as valuable as a ten rupee note simply because the Reserve Bank of India (or the government) says so. The ink and the paper used in a 100-rupee note is not ten times as valuable as the ink and the paper used in a ten-rupee note.

Paper money essentially works on confidence, which the government by recognising it as official money, helps build.  Further, it continues to have value, typically as long as people using it, continue to accept it. I will accept a payment in paper money only when I am sure that I can use that paper money to make my payments in the future.

As Mervyn King, former governor of Bank of England, writes in his new book The End of Alchemy: “Whatever form money takes, it must satisfy two criteria. The first is that money must be accepted by anyone from whom one might wish to buy ‘stuff’ (the criterion of acceptability). The second is that there is a reasonable degree of predictability as to its value in a future transaction (the criterion of stability).””

As per King’s second point, the confidence in paper money breaks down if it starts lose value at a very rapid rate i.e. when the prevailing inflation touches high levels. People then don’t like the idea of being paid in paper money because it is rapidly losing its purchasing power. In such scenarios people like being paid in the form of gold or silver or some other commodity.

In India, the first condition that King lays out, the criterion of acceptability, breaks down in case of a torn note. The moment a note is torn, it is not accepted as a payment even though it continues to be a legal tender. And it is not accepted as a payment by one person because he knows others won’t accept it.

What seems to be rational at an individual level becomes irrational at the systemic level. Meanwhile, I think I will have to finally make that trip to the bank.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared in the Bangalore Mirror on March 30, 2016

Why I Watch Cricket on Mute

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Over the four-day long weekend between March 24 and March 27, two exciting cricket matches were played. The Indian cricket team won both the matches.

I saw both these cricket matches end to end, but I had my TV on mute. I do this because I strongly feel that on most occasions TV commentary does not add any value to the visuals on the screen. And honestly, if there was an option which allowed me to just listen to the noise coming from the stadium, without the commentary, I would choose it.

Most cricket commentary and analysis is full of hindsight bias. And what is hindsight bias? As Jason Zweig writes in The Devil’s Financial Dictionary: “Only perhaps a half dozen market pundits saw the financial crisis coming before 2008, but you can’t swing a Hermès necktie on Wall Street without hitting someone who claims to have predicted it. That is typical of hindsight bias, the mechanism in the human mind that makes surprises vanish. Once you learn what did happen, your mind tricks you into believing that you knew it would happen.”

Take the match between India and Bangladesh. Bangladesh had almost won the match and needed to score two runs of three balls. They lost three wickets of the last three balls and India won the match by one run. Of these three wickets, two batsman got out trying to finish the game by hitting a six.

I think the Indian captain Mahindra Singh Dhoni summarised the situation best in what he said after the match: “At times, you look to finish it with a big shot. When you are batting well, you go for it. It is a learning for him [Mahmudullah] and others who finish games. That is what cricket is all about. If it had gone for six, everybody would have said what a shot.”

The trouble is that the Bangladeshi batsman Mahmudullah got out trying to hit a six and win the game for his team. And the commentators immediately pounced on him and declared that he should not have gone for the glory shot. The Bangladeshi cricketers were also called chokers. Nevertheless, if Mahmudullah had been able to hit a six, the same set of commentators would have had good things to say about him.

As Dhoni further said:In-form batsmen often try to play big shots to finish the game. If that shot by Mahmudullah had crossed the ropes, he would have been hailed as a courageous gutsy batsman. Now he will face criticism for playing such a shot.”

An almost similar thing was at view when Virat Kohli single-handedly helped India beat Australia. After India won, the commentators kept talking about his aggression and how it helped him play the innings that he did. The point is that if he had gotten out, the same aggression would have been blamed for his and the Indian team’s downfall.

The outcome of the game determines the analysis that follows. And the confidence with which the commentators speak makes you believe that they had really seen it coming. Of course, the fact that they have played the game in the past, adds to the confidence that they are able to project. But do they really see it coming? I don’t think so.

They day batsmen get out trying to hit shots, the analysis blames them for hitting rash shots. On days these shots come off, the commentators feel that taking a certain amount of risk is a very important part of modern day cricket.

In fact, hindsight bias impact even the commentary that accompanies every ball that is bowled and not just the analysis accompanying the overall result of the match. In the India versus Australia game, I was listening to the Hindi commentary and I think Shoaib Akhtar was speaking (though I am not sure about this) at that point of time. Virat Kohli hit a ball in the air and from the initial looks of it, it seemed that the ball would not cross the boundary and an Aussie fielder would take the catch.

So the first thing Akhtar said was “Kharab shot (A bad shot)”. Just a second later the ball had sailed across the boundary, Kohli had hit a six, and Akhtar said: “behtareen shot (what a good shot)”. Akhtar’s commentary immediately took into account the end result (i.e. Kohli hitting a six) and what was a bad shot suddenly became a terrific one.

The question is why does this happen? The Nobel Prize winning psychologist Daniel Kahneman has an answer for this in his book Thinking, Fast and Slow. As he writes: “The mind that makes up narratives about the past is a sense-making organ. When an unpredicted event occurs we immediately adjust our view of the world to accommodate the surprise. Imagine yourself before a football game between two teams…Now the game is over, and one team trashed the other. In your revised model of the world, the winning team is much stronger than the loser, and your view of the past as well as the future has been altered by that new perception.”

Then there is this other point that Dan Gardener writes about in Future Babble: “After a football team wins a game, for example, all fans are likely to remember themselves giving the teams better odds to win than they actually did. But researchers found that they could amplify this bias simply by asking fans to construct explanations for why the team won.”

This is precisely what happens to cricket commentators and the analysis that they have to offer after any game of cricket is over. Given that they have offer explanations of why the team wining, actually won, they end up amplifying the hindsight bias.

Depending on the result, the commentators offer an analysis. Some of it can be as banal as the winning side fielded better, batted better and bowled better (Something that Mohammed Azharuddin used to say all the time in his post-match comments when he was the India captain).

This is not to say that this analysis is incorrect, but why do we need a commentator to tell us this. It is very obvious. On most occasions a team that bats better, bowls better and fields better, is likely to win.

The hindsight bias also impacts stock market experts and analysts who try and make sense of the stock market on a regular basis. After a crash you will hear all kinds of pundits trying to claim they had seen it coming all along. And believe me they will make a very compelling case for it.

Nevertheless, it is important to keep in mind what Jason Zweig says. As he writes: “Contrary to popular cliché, hindsight is not 20/20; it is barely better than legally blind. If you don’t record and track your forecasts, you shouldn’t say that you knew all along what would happen in the end. And if you can’t review all predictions of pundits, you should never believe that they foresaw the future.

And that is something worth remembering.

The column originally appeared on the Vivek Kaul Diary on March 29, 2016