Your PF corpus is at stake if India goes Sri Lanka’s way

Is your provident fund (PF) at risk?

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This week Sri Lanka defaulted on its USD 51 billion external debt interest payment. Last month Sri Lanka’s foreign exchange reserves slumped to less than USD 2 billion, so the writing was on the wall, and when it happened, it did not surprise many.

In 1991 India too was only a few weeks away from defaulting on its external obligations. Only an emergency loan from the IMF (International Monetary Fund) helped it avoid the default. Top central bureaucrats almost a month back warned Prime Minister Narendra Modi that India could go Sri Lanka way if the populist scheme announced during elections is not curbed.

Govt of India (GoI) has been running a fiscal deficit for many years, and states are not too far behind. This essentially means that the GoI and states are spending more than their income and to balance the budget are taking loan to pay for the deficit.

To borrow from the financial market, RBI acts as an investment banker to the GoI by issuing treasury bills (short term loans) and bonds or dated securities (long term), whereas states can issue only bonds called SDLs (State Development Loans). These are called G-Sec (Government Security), and for all practical purposes, these financial instruments are considered risk-free as the government of the day has the power to raise taxes on its citizens and corporates to pay for the debt commitments.

But we saw a few years back in 2012 that this power is not unlimited as Greece too defaulted on its debt payment. Greek govt too tried to raise taxes to avoid default, but the citizens revolted against it. The point is that Sovereign Govt has defaulted in the past and might default in the future if they are unable to come up with money to pay for its debt obligations.

How could India defaulting on its debt impact your EPF Corpus?

GoI via a Gazette Notification, mandates both EPFO (Employee Provident Fund Organisation) and exempt organizations to invest a minimum of 45% and up to 50% of its corpus into Govt Securities, other securities fully guaranteed by Central or any State Govt, and Mutual Funds (MF) dedicated to investing into G-Secs and regulated by Securities and Exchange Board of India (SEBI). So, 45-50% of your EPF corpus is invested in sovereign debt at any point in time.

So, if GoI goes belly up like what happened with Sri Lankan Govt, your EPF corpus is too at stake. India’s national debt of USD 2.35 trillion (GoI debt) constitutes both external debt (the money owed to foreign lenders) and internal debt (the money owed to lenders in the country).

The good news is that external debt as % of national debt is less than 10% whereas, in the case of Sri Lanka, it was more than 60%. But the bad news is that this means that GoI owes more than 90% of its debt to internal debtors who lend it money. That includes EPFO, a major buyer of its bonds due to statutory requirements. So, you see, if GoI defaults, your EPF corpus could be wiped out too.

What can you do to avoid wiping out a significant portion of your retirement corpus?

The answer to that is 3 words: Diversification, Diversification, and Diversification. EPFO, too is diversifying into multiple investment instruments. Since 2015 it has started investing a minimum of 5% and up to 15% of its assets into equities and related instruments. So, follow its cue and invest in equity for your long-term goals, such as retirement, based on your risk appetite.
Also, consider the happenings in Sri Lanka as an eye-opener and not as a canary in a coal mine. With its growing economy, India can manage its national debt for a while if its economy is expanding, and it can collect enough revenue to pay for its yearly debt payments. But remember the lines from Ernest Hemingway’s novel The Sun Also Rises, when Bill asked Mike, “How did you go bankrupt?”. “Two ways,” Mike replied. “Gradually, then suddenly.”

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