Retirement Rejig!

Channelizing Retirement Flows into Equities….

It is odd that in every financial year , heightened expectations  orchestrated by non-stop news channels ,  build up on the eve of financial budget , only to be met with a  mediocre one later, disappointing investors at large. This ritual has replayed in the recent budgets quite regularly in a predictable fashion . This year was no exception , except that the mumbo-jumbo was more magnified this time , given the aura around the current dispensation in the finance ministry.

Though the budget lacked fireworks , it did have some bright spots esp. when it came to capital markets . The most notable one is on the  Govt’s plan to provide more options for retirement savings   . It is the fillip that FM has given to NPS  ( National Pension Scheme) in this budget that has the potential to be a game-changer for domestic structural equity flows  . For the uninitiated , NPS is a voluntary pension scheme, which is regulated by the Pension Fund Regulatory and Development Authority. However, unlike the employee provident fund (EPF), investors opting for NPS have the option for choosing stocks, government bonds and other securities as their asset choice. The equity part of the allocation is capped at 50 per cent.

This proposal of FM to allow employees to have an option to chose between EPF and NPS for their self contribution , has the potential to raise the stake for domestic flows substantially . Not to forget that the budget has also provided additional tax break of 50K under 80CCD for NPS . Since NPS has the mandate to invest upto 50% ( min of 15%) in equity viz-a-viz EPF which does not invest in stocks , the quantum of flows that can potentially move into stocks from retirement savings over time is staggering.  This NPS stimulus ( for lack of better phrase) is structurally positive for Indian equities . Indian stock market has been vulnerable to wild swings time and again because of  its over-reliance on FII flows . Stimulating sticky domestic flows will overcome this problem over time . NPS measures are an attempt in this direction.  Ironically  , it hasn’t got the deserved attention from the business media. Not so surprisingly , market with their sights fixed on short-term gyrations , has blissfully ignored this landmark proposal.

Moving on to some number crunching , based on the estimates of annual flows of about Rs 600Bn (appx) into EPF , the potential flows into equities from the EPF-to-NPS switch  can be near Rs 100 Bn annually . This is taking the mid-point of permitted range ( between 15% and 50%) for equity  allocation from the employee contribution of Rs 300 Bn ( 50% of the total annual EPF flows) . Add to this , the substantial jump that is expected in the organic incremental flows into NPS itself , driven by the additional tax break that has been provided in this budget. Overall one is looking at potential annual flows of over Rs 150 – 200 Bn over time from this channel . To understand the significance , this is over 50% of what the  all equity mutual funds put to-gether invested in stocks last year .

Sceptics might argue that the tax treatment is more favorable to EPF as it enjoys EEE ( Exempt-exempt-exempt) while taxation is done on EET (Exempt-exempt-tax) for NPS i.e. withdrawal will be taxed on indexation method . Though this tax anomaly is widely expected to be corrected soon , even at the present form , NPS can provide a much higher post-tax yield given its exposure to equities . Hence , this tax tangle is unlikely to taper the  impact on the long-term flows into NPS .

It is ironical that the markets have turned muted  precisely when certain long term measures are taking hold . That is hardly a surprise for seasoned investors accustomed to market’s maverick movements .

ArunaGiri . N