NEW DELHI: Employees’ Provident Fund Organisation is discussing a dedicated Rs 25,000-crore Interest Stabilisation Reserve, designed to insulate the annual interest payouts of its nearly 30 crore members from the turbulence caused by corporate bond defaults and forced-exit losses.Officials said EPFO and government want a stable regime for its subscribers and wish to avoid any sharp fall or spike in rates due to market conditions or defaults.Under existing regulatory frameworks, credit losses and exit haircuts, resulting from downgraded securities, directly impact EPFO’s interest account and depress the annual interest rate for members.
Report on ISR sent to panel studying EPFO investment framework
A proposal submitted by IIM Kozhikode, which among other things studied the feasibility of creating an Interest Stabilisation Reserve (ISR), was discussed in detail by EPFO’s investment committee (IC) Thursday, TOI has learnt.The report has now been sent to a high-poweredJ panel constituted to examine the agency’s investment framework and recognise non-performing investments.The report suggested building the stabilisation reserve progressively via surplus ETF capital gains and excess interest income and investing it strictly in liquid govt securities (G-Secs) to ensure absolute capital safety, sovereign backing, immediate liquidity, and risk-free yield, said persons familiar with the deliberations.The reserve will not only shield subscribers but will also back active exit policies and empower portfolio managers to execute disciplined, multi-year exits from troubled assets without hesitation.The report took into account the current realities of India’s over-the-counter (OTC) corporate bond market, which remains shallow and illiquid, such that when institutional holders such as EPFO are forced to exit distressed assets, thin market depth results in severe haircuts.Historically, EPFO relied heavily on equity ETF capital gains to offset credit stress.The report, however, noted that the volatile market downturn of FY 2019-20 coincided with major credit events like the IL&FS default, which exposed a critical vulnerability.“Credit stress and equity market crashes are highly correlated. Relying solely on ETF gains is dangerous; a standalone prudential reserve is a structural necessity,” it said.The study evaluated absolute worst-case liquidation scenarios across the portfolio netted against available ETF gains, pinpointing a cumulative baseline shortfall of approximately Rs 23,837 crore.“To account for incomplete market data and ensure a bulletproof prudential buffer, the report recommends formalising an ISR Fund of Rs 25,000 crore,” it said.
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The study also ran a historical back-testing simulation which modelled portfolio returns from 2010-11 to 2023-24, demonstrating that a Rs 25,000-crore baseline successfully absorbs annual shortfalls and stabilises declared interest rates across typical economic cycles.The only exception was 2019-20, where portfolio deficit spiked to Rs 55,640 crore, leading to deep drawdown from the reserve.“However, the subsequent recovery in investment performance in later years indicates that such a shortfall would likely have been temporary in nature.In such a scenario, EPFO could have bridged the temporary deficit through a short-term advance or loan mechanism, which could subsequently be repaid from future surpluses generated during recovery years,” the study said.
