EPF in the Hands of the Central Bank

When the government used the funds of Employment Provident Fund (EPF) to invest in publicly traded financial companies in 2011, civil groups and the opposition party vehemently protested against government’s move to exercise control. It became known in 2014, the government has indeed incurred losses from the ventures and the losses have to be transferred to the beneficiaries. Ironically, the new government, the very people who voiced their opinion against the moves continue to maintain shares and attempt to increase their influence over private banks. As of now, the government owns shares of 6 different privately owned banks, with stakes varying from 16.3 percent to 33.98 percent. The Central Bank’s (CB) failure to publish annual reports of the EPF since 2012 makes the whole affair of EPF and CB’s decision to invest in private financial companies increasingly dubious.

 

What Is EPF?

If you have been an employee in Sri Lanka you are aware  that a certain amount of your monthly paycheck is deducted for the EPF. The Employment Provident Fund was set-up under the Act No. 15 of 1958 as a social security scheme. The Central bank is entrusted to maintain the fund. It has grown to become the largest social security scheme in Sri Lanka amounting to 1664 billion rupees as at December 2015. The employee has to contribute 8 per cent and the employer 12 percent of the monthly salary. Therefore the entire fund comprises of the hard-earned money of Sri Lanka’s labor force. The large public outcry was initially due to jeopardizing this fund by risky investment which in-turn endangers the social security of Sri Lankans. It Appears that there are even more serious implications of CB owned shares and influencing bank decisions through government-appointed directors.

 

The Conflicts of Interest

According to the CB website, one of its objectives is to achieve financial system stability. The Central Bank oversees the financial institutions and makes sure the banks make “safe and efficient” financial decisions. Having to manage its portfolio, the CB is now playing the dual roles of the regulator and the financial institution it is supposed to regulate.  It is questionable how the CB intends to strike a balance between the drive to profit while  regulating the country’s financial environment. The CB is essentially regulating the companies owned by itself.

The CB also has to set the interest rates which directly affect the financial institutions’ daily transactions. In a situation where the CB owns banks, it is essentially setting interest rates of companies owned by itself. This does not only give rise to a conflict of interest. The financial institutions can clearly exploit the inside information and get undue advantage. In a fiercely competitive banking environment where the players are striving to gain an edge, inside information will be detrimental to the industry competition. In other words, the CB could be directly involved in creating monopolies in the banking system.

CB has already tainted its name by allegedly getting involved in a bond scam in 2015. Its stakes in private financial companies could potentially embroil the CB in yet another misuse of information. When the CB issues bonds and debentures in order to raise finances on behalf of the government, it has to act in the best interest of the people in the country. In other words, the treasury bills or bonds should be issued to the bidder that offers the lowest rate of interest. These transactions are in billions and therefore a fraction of an interest rate means a lot. The Central Bank’s portfolio comprises the stakes of the very companies that wishes to profit from the deals.

 

Unclear Rationale

The governments have had a history of not publicizing important economic reforms affecting the citizens. In defense of the claims regarding EPF, government’s response has been that the purchase of shares is a reaction to “news items alleging fraud and market manipulations in share transactions”(The Island June 23, 2012). The claim itself is vague and it appears as if the government is finding faults of other institutions in order to execute a hidden agenda. On the other hand it raises effectiveness of the Securities and Exchange commission which is in place to detect and investigate share price manipulations.

The government and the CB has gone to unprecedented lengths to tackle a market imperfection by creating a web of more serious complications. Coupled with the failure to produce annual reports of EPF for four consecutive years,  the entire affair has created an aura of extreme ambiguity. Thus, people believe the move is an attempt of some invisible hand to steal the hard earned money of workers.

Hands-Off Private Companies

When John Exter, the founder of the central bank released his reports, he forbid the CB from engaging from any profit making activities. Although the financial and the economic climate has transformed so much since then, his reasoning has only grown in its significance. Therefore the CB is now in violation of the Exter Report as well.

Regardless of any foul play, CB managing a portfolio itself is a red flag to a potential investor. The investors would not want the government to directly meddle with their decisions through government-appointed directors sitting in their board meetings. It undermines private ownership and free-market policies. It also discourages private investment and foreign direct investment. It is ironic that a party which is known for its pro-market policies has, in a way, nationalized privately owned companies by owning shares. Therefore this is a serious dampener on the government’s aim to encourage entrepreneurship and investment.

 

Possible Solution

Provident funds are widely found all around the world. One solution is to transfer the fund to an independently specialized and separate body. The body should be completely independent of the CB and independent of political influences. It resolves two problems. Firstly it relieves CB from the conflicts of interest which is the major part of the problem. This way the CB will have no barrier to hold shares of financial institutions(FI). Yet I would strongly suggest not holding shares of FI. The independent body will likely comprise of officers who have strong ties to the CB who are already experienced in managing the EPF. Thus it will not give rise to a problem like Food And Drug Administration Authority directors coming from Tyson.

Secondly this specialized team will be well versed in investment decisions thus capable of actually growing the fund and not dwindling the fund. The government has not had a very good track record of investment over the years and there are ample examples of disastrous ventures. The fund has already lost 11.7 billion of rupees due to inept and politically motivated investment decisions (Daily Mirror).The special team will comprise of investment analysts and market researchers who are geared to make strategic investment decisions. It is of utmost importance that the body is free of any political motivations. This will enable the fund to provide the beneficiaries with a healthy interest rate that would be well over the inflation rate.

While I agree that the solutions are easier said than done, given the magnitude of the problem the changes should be made to for the betterment of the economy. The governments seems to be pushing any solution to a distant horizon by adopting the same unhealthy policies the previous governments carried out. The solution will not only benefit the economy as a whole, but also would establish “good governance” that the present government pledged to uphold once they rise to power.

(* the writer Praveen Ekanayake is a graduate student of Miami University )

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