Investing

Is It Time to STOP Drinking Stocks SIP by SIP?

Summary: The idea at the heart of systematic investment plans (SIPs) is cost averaging and it works when the stock market goes both up and down. In the last seven years, the market has largely gone only one way and that’s up. Hence, SIPs have given fairly ordinary returns.  

In the last decade and a half, regular investing into equity mutual funds through the systematic investment plan (SIPs) route has become a regular habit for many middle-class Indian investors. And its been a good habit.

Given that money invested in equity mutual funds is used to buy stocks, SIP investors end up owning stocks indirectly.

Also, mutual funds need to invest in a certain minimum number of stocks to meet regulatory requirements, hence, the old investment adage of don’t put all your eggs into one basket, gets taken automatically care of.

Nothing Works Forever

As the old Hero Honda advertisement went, fill it, shut it, forget it. SIPs are a tad like that.

The trouble is nothing works forever. What made SIPs such an easy and a beautiful way to invest is the concept of cost averaging that comes into play.

What exactly is cost averaging? Let’s say you invest Rs 10,000 per month into a mutual fund through an SIP. On the day of investment, the net asset value (NAV) of a single unit of the mutual fund is Rs 40. You end up buying 250 units (Rs 10,000 divided by Rs 40). The NAV of a mutual fund is the price at which an investor can buy or sell a single unit of the fund.

Let’s say a year later, the stock market has fallen and the NAV of the mutual fund has fallen to Rs 20. This time when you invest you end up buying 500 units (Rs 10,000 divided by Rs 20).

Essentially, you end up buying more units when the stock market is doing badly, and you buy fewer units when the stock market is doing well. When the market recovers, it is the units that were bought when the NAV was low, which bring in the maximum return.

Also, since most retail investors don’ know exactly when the stock market is going to fall (this is not to say that the so-called experts and talking heads on TV, do), an SIP strategy needs the investor to keep investing for the long term. The question is how long is the long term? Of course, there is no definitive answer for this.

I still remember when mutual funds first started talking aggressively about SIPs a decade and a half back, they used to talk about an investment horizon of three years. A few years later this investment horizon became five years.

In my personal experience, having invested in mutual funds through the SIP route for nearly 15 years, I think the real fun starts only after ten years. This is when the stock market has gone through various cycles and the investor has ended up buying enough mutual fund units during periods when the stock market was doing badly.

And as mentioned earlier, these are the units help the investor earn a good return when the stock market starts to do well again.

Of course, this is not the best possible way to invest but a pretty optimum one, especially for individuals who are busy running the rat race of corporate life and trying to balance it with their very demanding family and social lives as well. All this doesn’t really leave much time for them to research and invest in stocks directly. Hence, investing in stocks through the SIP route turns out to be a reasonably good bet.

The corollary to all this is that for SIPs to work the stock market needs to come down time to time as well.  Only then does the SIP investor end up buying units at lower NAVs, which benefit him later (I know I can’t seem to hammer this point enough).

But over the last few years, the stock market has only gone in one direction and that is up. Take a look at Figure 1, which basically plots the price to earnings ratio of the Nifty index.  It might look a tad complicated to everyone who switches off when they look at any chart but believe me this is very simple.

Figure 1: Price to earnings ratio of the Nifty 50 Index.


Source: www.nseindia.com

Let’s divide the chart into two parts, pre 2013 and post 2013. Pre 2013, the price to earnings ratio has gone up and down and up and down and so on. Post 2013, it has largely gone only one way and that is up (except the one big fall earlier this year).

What does that mean? It basically means that the prices of stocks that make up for the Nifty 50 index have gone up much faster than the earnings of the companies these stocks represent.  And this has gone on for seven years now.

Stock prices ultimately should be a reflection of expected future earnings of any company. But when the price to earnings ratio keeps rising for seven years at a stretch what it means in simple English is that the price of the stocks has gone up much faster than their earnings and the expected future earnings of the companies have never really materialized.

As of August 18, the price to earnings ratio of the Nifty 50 index stood at 32.03, the all-time highest level (in the data that is available since 1999). The average price to earnings ratio since 1999 has been around 20. This tells us clearly how high the current stock price to earnings ratio is.

The question is how did we reach here? Take a look at Figure 2, which basically plots the inflows or the money being invested into SIPs every month, since April 2016.

Figure 2: SIP inflows (in Rs crore).


Source: AMFI India.

Before we interpret Figure 2, let’s take a look at Figure 3. Figure 3 plots the money invested by foreign institutional investors (FIIs) into Indian stocks over the years.

Figure 3: FII investment into Indian stocks (in Rs crore). 

Source: NSDL.

What Figure 3 tells us is that between 2015-16 and 2019-20, foreign investors did not invest much in Indian stocks, except in 2016-17, when they invested Rs 55,703 crore. Hence, during that period it was money coming through the SIP route which was invested into equity mutual funds and then into stocks, that kept the stock prices buoyant despite the company earnings not seeing the expected growth.

As ironic as it might sound, it was money coming in through the SIP route which essentially ensured that stock prices did not fall, and in the process ensured that cost averaging went out of play.

Before SIPs became a popular of investing, between 2012 and 2014, the foreign investors invested a lot of money into Indian stocks. Money invested by the foreign investors and SIP investors over the last seven years has ensured that the Indian stocks have been at levels their earnings do not justify. Nonetheless, the hope still persists that these stocks will someday give earnings they are expected to. But hope cannot be an investment strategy.

Hence, the part of cost averaging where stock prices fall and which leads to SIP investors ending up buying more mutual fund units, hasn’t really played out in the last seven years.

Take a look at Table 1 which basically lists the SIP returns of three index funds, as of August 18, 2020. Index funds are mutual funds which invest in stocks that make up for a particular index.

Table 1: SIP returns of index funds.

Source: Value Research and National Stock Exchange.

What does this table tell us?

1) Over the last few years, the stock market has just gone one way and that is up. This has led to fairly limited SIP returns. Even the 10-year SIP returns of index funds are not in double digits. And if 10-years is not long enough, I don’t know what is.

2) What we also come to realise is that the SIP returns are on the lower side, despite the stock market valuation being at an all-time high level. Hence, all the money brought in by the SIP investors and the foreign investors has led to just about mediocre returns even over a 10-year period.

Lest we get accused of looking at the returns only on a certain date, let’s take a look at 10-year returns of these index funds in previous years.

Table 2: 10-year SIP returns of index funds.

Source: Value Research.

Table 2 makes for a very interesting reading. The 10-year SIP returns in years before 2020, are higher. In fact, if we leave out 2019, largely they are in double digits or very close to double digits. The reason for this lies in the fact that the 10 year-SIPs before 2019, ran through a longer-periods of the stock market going down (go back and look at Figure 1 again). This allowed cost averaging to come into play properly, something which hasn’t happened in the past few years.

Using this logic, a few months back I completely stopped all my SIPs. Honestly, there hasn’t been a more SIP man than me, having relentlessly been at it for close to 15 years. Whatever little I have saved in life is thanks to SIPs.

Of course, this is the past.

What about the future?

As long as the direction of the market stays one way and it doesn’t fall for an extended period of time, SIPs as a way of investing will have a fundamental flaw, as explained earlier. Hence, the 10-year returns one saw around between 2014 and 2018, are unlikely to be repeated in the years to come.

For a period of 18 months between November 2018 and May 2020, more than Rs 8,000 crore was invested into mutual funds every month through the SIP route. In the last two months, the investment has fallen below Rs 8,000 crore, nevertheless, it still remains strong. A bulk of this money has gone into equity mutual funds.

The foreign investors ignored Indian stocks for the last few years. But in 2020-21, the current financial year, they have come back with a bang. The reason for this lies in the fact that there a lot of money printing happening across the Western world.

Between February 26 and August 12, the Federal Reserve of the United States has printed close to $2.8 trillion in a bid to drive down interest rates in the United States and help the post-covid economy.

As has been the case in the past, some of this money has been invested in stock markets all across the world including India. The easy money policy of the Western central banks is likely to continue in the months to come, at least for the next one year, until the world starts coming out of the economic contraction that is happening thanks to covid.

In this scenario, the chances of the stock market and the price to earnings ratios falling, are rather low. Another reason which will ensure that stock prices may not fall is the fact that post tax bank fixed deposit return is now lower than 5% in most cases and the inflation is close to 7%. Hence, a segment of savers will try to drive up the investment return by buying stocks.

Whether the stock market will go up from here, the situation is too convoluted to say anything definitively. For that to happen, much more money needs to be invested into the stocks.

If as an investor you feel that stock prices will only go up from here despite the lack of company earnings, then you are better buying stocks directly and making irregular one-time investments into equity mutual funds than going through the SIP route. By going through the SIP route, you will keep escalating the cost of purchase of mutual fund units and in the process drive down returns.

That’s the way I see it at least. And I say it, the way I see it. The time to fill it, shut it, forget it, when it comes to SIPs, is over.

Disclaimer: The article is meant for educational purposes only.

The Old-New Investment Lessons from the Recent Stock Market Crash

bullfighting
It took the BSE Sensex, India’s premier stock market index, a period of nine months (from late April 2017 to late January 2018), to go from 30,000 points to higher than 36,000 points. This meant a return of more than 20% in a period of just nine months.

In an era when fixed deposits give a post-tax return of 5% per year, a return of 20% in less than a year, has to be fantastic. Of course, there are many listed stocks which have given more than 20 % returns, during the same period.

Between January 29 and February 6, 2018, the BSE Sensex has fallen by around 5.8% and wiped out one-third of the gain between April 2017 and January 2018. A week’s fall has wiped off one-third of the gain over a period of nine months.

When the stock market falls, a new set of investors learn, the same set of lessons all over again. What does this mean?

The price to earnings ratio of the BSE Sensex crossed 26 in late January 2018. This basically means that an investor was willing to pay Rs 26 for every one rupee of earning for the stocks that make up the Sensex.

Between April 2017 and January 2018, the price to earnings ratio of the Sensex had moved from 22.6 to 26.4. This meant that while the price of the stocks kept going up, the profit of the companies they represent, did not move at the same speed. Ultimately, the price of a stock is a reflection of the profit that a company is expected to make.

The price to earnings ratio of NSE Nifty touched 27 in late January 2018. The midcap stocks were going at a price to earnings ratio of 50. And the small caps had touched a price to earnings ratio of 120.

Such price to earnings ratios, or what the stock market likes to call valuation, were last seen in 2000 and 2008. With the benefit of hindsight, we now know that at both these points of time, the stock market was in a bubbly territory.

In fact, all the occasions when the price to earnings ratio of the stock market was greater than in the recent past, were either between January and March 2000, when the dotcom bubble and the Ketan Parekh stock market scam were at their peak, or between December 2007 and January 2008, when the stock market peaked, before the financial crisis which finally led to many Wall Street financial institutions going more or less bust, broke out.

Nevertheless, the stock market experts told us that this time is different because there was no bubble in the United States of the kind we saw in 2000 or that the financial crisis that broke out in 2008, was a thing of the past. Hence, there was no real reason for the stock market to fall. (Of course, to these experts, the lack of earnings growth did not matter).

The trouble is that when the markets are in bubbly territory, there typically is no reason for them to fall, until some reason comes along. The first reason came in the form of the finance minister Arun Jaitley, introducing a long-term capital gains tax of 10% on stocks and equity mutual funds. This tax will have to be paid on capital gains of more than Rs 1 lakh, starting from April 1, 2018.

Investors took some time to digest this, and the stock market fell by 2.3%, a day after the budget. If this wasn’t enough, the yield on the 10-year treasury bond of the American government came back into the focus.

This yield jumped by around 40 basis points to 2.85%, in a month’s time. This yield sets the benchmark interest rates for a lot of other borrowing that takes place. In the aftermath of the financial crisis that broke out in September 2008, the central banks of the Western world, led by the Federal Reserve of the United States, printed a lot of money to drive down interest rates.

This was done in the hope of people borrowing and spending money and the economies recovering. That did not happen to the extent it was expected. What happened instead was that large financial institutions borrowed money at low rates and invested them in stock markets all across the world. This phenomenon came to be known as the dollar carry trade.

All this money flowing in drove up stock prices. The problem is that as the 10-year treasury bond yield approaches 3 %, dollar carry trade will become unviable in many cases. Given this, many carry trade investors are now selling out of stock markets, including that of India.

The larger point here is that nobody exactly knows when the stock market will reverse. The way the market has behaved over the last few days, has proved that all over again.

The sellers are not selling out because the valuations are too high (they were too high even a month or two back). They are selling out because of an entirely different reason all together; investors are selling out because they are seeing other investors selling out. The herd mentality that guides investors to buy stocks when everyone else is, also forces them to sell when everyone else is.

Also, the stock market, when it falls can fall very quickly. The last generation of stock market investors learnt this when the BSE Sensex fell by close to 60 % between January 9, 2008 and October 27, 2008.

Is it time for this generation of stock market investors to learn the same lesson all over again? On that your guess is as good as mine.

Stay tuned!

The column originally appeared on Firstpost on Feb 6, 2018.

Buys High and Not Low: That’s the Indian Investor for You

bullfighting

“Buy Low, Sell High,” goes the old stock market wisdom.

But like most stock market wisdom, this is easy to mouth, but difficult to implement in real life. It is very difficult to buy when others are selling and vice versa.

The tendency is to go with the herd because there is safety in numbers. And if things don’t work out as intended, one has someone else to blame as well. “I only did what Mr Singh’s son recommended,” goes the argument.

The question is how do numbers look on this front? Do investors actually buy when market levels are low and sell when market levels are high. Or are they doing exactly the opposite?

Take a look the following chart. That is how the Sensex has looked between April 1, 2011 and March 31, 2016. As can be seen from the chart, the overall trend of the Sensex has been in the upward direction, though it did fall during the course of 2015-2016.

 

Now take a look at the following table.

YearShares and Debentures
(as a % of GNDI)
2011-20120.2
2012-20130.2
2013-20140.4
2014-20150.4
2015-20160.7

Source: Annual Report of the Reserve Bank of India

The table shows the portion of gross national disposable income (basically the GDP number adjusted for a few other things. For a detailed treatment click here) made up for by investments in shares and debentures, which are a part of the household financial savings. In 2011-2012, shares and debentures made up for 0.2 per cent of the gross national disposable income. By 2015-2016, this had jumped up to 0.7 per cent. The household financial savings comprise of currency, deposits, shares and debentures, insurance funds, pension and provident funds and something referred to as claims on government. The claims on government largely reflects of investments made in post office small savings schemes.

What the table clearly tells us very clearly is that a very small portion of Indian retail investors invests in shares and debentures. In fact, these numbers also include the mutual fund numbers.

What do we learn from the chart and the table? As the Sensex went up, so did the investments in shares and debentures.

The trouble is that for some reason, which actually makes no sense, the RBI puts out the data for shares and debentures together. A breakdown of the total amount of money held in the form of shares (or debentures for that matter) is not available. But with the help of some other data we can prove that the Indian investor basically follows the policy of buying once the stock markets have rallied.

As on March 31, 2011, the total amount of money held in equity mutual funds in India had stood at Rs 1,69,754 crore. By March 31, 2016, this number had stood at Rs 3,44,707 crore. The assets under management increase in two ways. The first is because the value of the shares held by the mutual funds goes up. And the second is because of the fresh money being invested into the mutual funds.

As we can see the assets under management have more than doubled in the five-year period. On the other hand, the Sensex returns during the period stood at 30.5 per cent. Hence, it is safe to say that the major part of the increase in assets under management was because of new money coming into the mutual fund schemes.

And this new money kept coming in as the Sensex kept going up. Take the case of what happened between March 31, 2015 and March 31, 2016. The Sensex fell by 9.3 per cent during the course of the year. The assets under management of equity mutual funds on the other hand, went up by 12.8 per cent.

In fact, during the period, the Sensex achieved its highest level on January 29, 2015, when it closed at 29,681.77 points. Between then and March 31, 2016, the Sensex fell by 14.6 per cent. At the same time, the assets under management of equity mutual funds went up by 14 per cent.

This is a clear indication of the fact that investors actually invest in equity mutual funds only after the markets have rallied. Once the market has rallied, the investors probably assume that it will continue to rally.

Hence, I guess, it is safe to say that a similar behaviour is on when it comes to direct investing in stocks as well. And that (along with increase in mutual fund investments) explains why the share of shares and debentures has increased from 0.2 per cent of gross national disposable income in 2011-2012 to 0.7 per cent in 2015-2016.

Of course, one would be able to say this with much greater confidence if the RBI gave an exact breakdown of shares and debentures. I hope that this anomaly is corrected in the days to come.

The column originally appeared in The Five Minute Wrapup on September 7, 2016

Here’s More Data to Show How Over-Priced Indian Real Estate Is

India-Real-Estate-Market

I know I am kind of going overboard with the analysis of the data released by the Income Tax department last week, but believe me it is necessary, to show how loaded things are against people who actually pay income tax.

Last week, the Income Tax department released some very interesting data-the kind of stuff that it had not released for a while.

It released detailed numbers for income tax returns filed in assessment year 2012-2013. In the assessment year 2012-2013, the income tax returns for the income earned in 2011-2012 was filed.

Let’s look at the income tax returns of individuals in detail. The Income Tax department has provided data for income for individuals under the head-salary, business income, other income, short-term capital gains, long-term capital gains and interest income.

Take a look at the following table:

This table tells us that the average income of individuals filing an income tax return is around Rs 4.40 lakh.

Table 1: Income under the head (in Rs crore)

Salary6,27,200
House property income29,927
Business income4,03,251
long term capital gain30,479
short term capital gains3290
Other sources income1,28,020
Interest income44,918
Total (in Rs crore)12,67,085
Total number of returns287,66,266
Average incomeRs 4,40,476

How do things look if we look at just the salaried class?

Table 2

Salary (in Rs crore)6,27,200
Number of returns filed116,76,493
Average incomeRs 5,37,148

As can be seen from the above table the average income of the salaried class in India filing income tax returns is Rs 5.37 lakh. This is around 22% more than the average income of the individuals filing income tax return.

It is important to understand here that most individuals belonging to the salaried class would have an income lower than the average income of Rs 5.37 lakh. In order to understand this, we will have to take a look at the data in a little more detail.

Let’s divide the data in those earnings up to Rs 10 lakh and those earning more than Rs 10 lakh. Let’s consider those earning up to Rs 10 lakh first (See Table 3). As can be seen from Table 2, the total number of returns filed by the salaried class comes to around 1.17 crore.

Of this close to 1.06 crore have salaried incomes of up to Rs 10 lakh. This means around 91% of the salaried class filing income tax returns have an income of up to Rs 10 lakh. Take a look at the following table (Table 3).

Table 3

Salary rangeNumber of returnsSum of Salary Income (in Rs crore)
>0 and <=1,50,00016,00,16714,956
>150,000 and <= 2,00,00010,67,30018,853
>2,00,000 and <=2,50,00010,24,31523,120
>2,50,000 and <= 3,50,00019,18,71457,075
>3,50,000 and <= 4,00,0008,06,68530,215
>4,00,000 and <= 4,50,0007,54,20232048
>4,50,000 and <= 5,00,0006,96,21033032
>5,00,000 and <= 5,50,0005,95,29831190
>5,50,000 and <= 9,50,00020,23,583140464
>9,50,000 and <= 10,00,0001,00,1559760
Total105,86,6293,90,713
Average IncomeRs 3,69,063

The average income of those earning up to Rs 10 lakh is Rs 3.69 lakh. This is significantly lower than the overall average income of Rs 5.37 lakh of the salaried class filing income tax returns. How do things look for those earning an income of up to Rs 5 lakh?

Table 4

Salary rangeNumber of returnsSum of Salary Income (in Rs crore)
>0 and <=1,50,00016,00,16714,956
>150,000 and <= 2,00,00010,67,30018,853
>2,00,000 and <=2,50,00010,24,31523,120
>2,50,000 and <= 3,50,00019,18,71457,075
>3,50,000 and <= 4,00,0008,06,68530,215
>4,00,000 and <= 4,50,0007,54,20232048
>4,50,000 and <= 5,00,0006,96,21033032
Total78,67,5932,09,299
Average incomeRs 2,66,027

The average income of those earning less than Rs 5 lakh is around Rs 2.66 lakh. These individuals form around two-thirds of the overall salaried class filing income tax returns.

How do things look for those earning more than Rs 10 lakh per year?

Table 5

Salary rangeNumber of returnsSum of Salary Income (in Rs crore)
>10,00,000 and <=15,00,0005,92,41871,464
>15,00,000 and <= 20,00,0002,07,14135,566
>20,00,000 and <= 25,00,0001,10,70024,708
>25,00,000 and <= 50,00,0001,24,47241,302
>50,00,000 and <= 1,00,00,00036,77525,032
>1,00,00,000 and <=5,00,00,00017,51530,661
>5,00,00,000 and <=10,00,00,0006554,375
>10,00,00,000 and <=25,00,00,0001562,158
>25,00,00,000 and <=50,00,00,00026809
>50,00,00,000 and <=100,00,00,0006412
Total10,89,8642,36,487
Average income21,69,876

The average income of those earning more than Rs 10 lakh per year comes to around Rs 21.7 lakh more and is significantly more than the overall average of Rs 5.37 lakh for the salaried class.

What do these tables tell us? That the average salaried Indian who files income tax returns doesn’t earn much. As mentioned earlier, around 91% of the salaried class has an average income of Rs 3.69 lakh. Close to two-thirds have an average income of Rs 2.66 lakh.

This basically means that the income of the average salaried Indian filing an income tax return is significantly lower than the overall average salaried income as well as overall average income. At least that is how things were for the assessment year 2012-2013.

A question worth asking here is what sort of a home can individual earning a salary of Rs 3.69 lakh per year, actually afford. An annual income of Rs 3.69 lakh translates into a monthly income of around Rs 30,755.

What sort of a home loan would a bank give against this amount? Typically, a bank works with the assumption that 40% of the monthly income can go towards servicing an EMI and accordingly gives a loan.

In this case that amounts to around Rs 12,300. An EMI of Rs 12,300 at an interest rate of 10% and a tenure of 20 years, would service a home loan of Rs 12.75 lakh. Banks typically lend up to 80% of the official value of the property. This means an official value of property of around Rs 16 lakh (Rs 12.75 lakh divided by 80%). Please take into account the fact that I have used the word official because there is bound to be a black component as well.

What this number tells us is that most salaried class in 2011-2012, were not in a position to buy a home to live in, across large parts of the country. There is no reason to believe that things would have changed since then.

The point is that the demand for real estate is in the below Rs 20 lakh market price segment. But what is being built across large parts of the country is clearly above that price. As RBI governor Raghuram Rajan said in a recent speech: “I am also hopeful that prices adjust in a way that encourage people to buy.”

Let’s wait and see if Dr Rajan’s hope becomes a reality, any time soon.

The column was originally published in the Vivek Kaul’s Diary on May 6, 2016

Why are People So Touchy About EPF

EPFOLogo

There has been a lot of drama surrounding the changes that the Narendra Modi government has tried to introduce in the Employees’ Provident Fund(EPF) in the recent past. It started with the government trying to tax the EPF.

In the budget speech made in February, 2016, the finance minister Arun Jaitley said: “I propose to make withdrawal up to 40% of the corpus at the time of retirement tax exempt in the case of National Pension Scheme. In case of superannuation funds and recognized provident funds, including EPF, the same norm of 40% of corpus to be tax free will apply in respect of corpus created out of contributions made after 1.4.2016.”

Just the word tax was enough to get the protests going. The social media went berserk. And so did television channels as well as newspapers, protesting vehemently against this move.

In clarifications that followed the actual plan of the government came forth. The change actually applied only to private sector employees who earned more than the statutory wage of Rs 15,000 per month.

If these employees chose to withdraw 100% of their EPF corpus, 60% of the corpus created after April 1, 2016, would be taxable. Further, there was a
around it. As the clarification later issued by the finance ministry pointed out: “It is expected that the employees of private companies will place the remaining 60% of the Corpus in Annuity, out of which they can get regular pension. When this 60% of the remaining Corpus is invested in Annuity, no tax is chargeable. So what it means is that the entire corpus will be tax free, if invested in annuity.”

The clarification did not help. The protests continued and the proposal to tax EPF was then withdrawn.  All this is well known by now. The question I want to ask here is, what led to the people protesting as vehemently as they did?

The middle class in this country is not known to protest against anything. They generally get around to accepting most things over a period of time. So what happened here? The answer perhaps lies in what behavioural economists refer to as the phenomenon of loss aversion.

And what is loss aversion? As economist Robert H Frank writes in his new book Success and Luck—Good Fortune and the Myth of Meritocracy: “[The] sense of entitlement to the fruits of one’s labours may owe much to the phenomenon known as loss aversion. One of the most reliable findings in behavioural economics loss aversion refers to the fact that people will fight much harder to avoid a loss than they would to achieve a gain of the same amount. Since most…people work hard for the money they earn, it feels like they own it, and that makes taxation feel like theft.”

And this precisely what explains all the protests that erupted against the government trying to tax the EPF. While protests in this case were justified, what followed was uncalled for.

Before trying to tax the EPF, the government had put out a notification on February 10, 2016. As per this notification an individual investing in EPF could withdraw only his contribution made to the EPF and the interest accumulated thereon, in case he was unemployed for a period of at least two months.

Before this notification was issued 100% withdrawal was possible. Further, those who changed jobs also withdrew 100% of their accumulated EPF. All they had to do was to declare that they were unemployed. This wasn’t a healthy phenomenon given that money invested into EPF is essentially being put aside for retirement.

The Employees’ Provident Fund Organisation(EPFO) was not structured to be able to keep track of individuals changing jobs. The introduction of Universal Account Number(UAN) along with the February notification, made it impossible for those changing jobs to withdraw 100% of EPF. And this was a good move.

But there were huge protests against this as well. And the government had to withdraw this notification. In fact, this happened primarily because people saw this as another attempt of the government to play around with their EPF and loss aversion kicked in.

In fact, the media created confusion around the question, by asking questions like why an employee should not be allowed to withdraw money for weddings, education of their children, building/buying a home and medical emergencies.

Take the case of an editorial that appeared in The Times of India on April 21, 2016. It asked: “People may need to withdraw from EPF to tide over a situation when they are between jobs. Or they may want to build a house. Or they may face a medical emergency. In all these cases EPF withdrawals enhance their economic security, which was the core idea behind EPF. There is no case, therefore, for debarring such withdrawals.”

This gave the impression that no withdrawal from EPF was possible anymore. This was totally wrong. Those unemployed could withdraw their contribution to the EPF as well as the interest accumulated on it.

Further, the EPF already had rules for money to be withdrawn for medical emergencies, housing, education as well as weddings. These rules were not fiddled around in the new notification issued on February 10, 2016.

The Section 68K of the Employees’ Provident Fund Scheme 1952, allows an individual to withdraw up to 50% of his contribution and the interest accumulated thereon, “for his or her own marriage, the marriage of his or her daughter, son, sister or brother or for the post-matriculation education of his or her son or daughter.”

As far as medical emergencies are concerned, the amount that can be withdrawn from the EPF should not exceed, the individual’s “basic wages and dearness allowances for six months or his own share of contribution with interest in the Fund, whichever is less.” Withdrawal is allowed for buying/building a home as well.

After hungama around this move ended, the government decided to cut the interest rate on the EPF for 2015-2016 to 8.7%. This was 10 basis points lower than the 8.8% recommended by the Central Board of Trustees(CBT) of EPFO. Further, it was 5 basis points lower than the interest of 8.75% paid in 2014-2015 and 2013-2014.

This means that the interest paid in 2015-2016 would have been Rs 50 per lakh lower than what was paid in 2014-2015. This is a very small amount. But there were protests against this move as well, primarily by trade unions.

The explanation for this again lies in loss aversion. People now believe that the government is trying to play around with their hard earned money. And any small change attempted on part of the government is likely to lead to protests.

These protests finally led to the government reversing its earlier decision and deciding to pay an interest of 8.8% on EPF for 2015-2016, as recommended by the CBT.

The question that crops up here is, what economic reforms can be expect from a government which isn’t even in a positon to pass on an interest rate cut of 5 basis points (from 8.75% in 2014-2015 to 8.7% in 2015-2016).

Further, the government could have handled the situation better by at least trying to explain the logic behind its moves. But that doesn’t seem to have happened and it has ended up with creating needless trouble for itself.

The column  originally appeared in the Vivek Kaul Diary on May 2, 2016