Pages

Wednesday, 23 November 2011

PPF interest rate increase. Ponzi Alert! Like Social Security? (Part IV)

I started off this series of posts, in response to the change in rules governing the PPF scheme.  The interest rate for the next financial year has been raised to 8.6% from the current 8% for the PPF scheme.  I believe any defined benefit scheme that promises returns well in excess of market rates is no different from a Ponzi Scheme.  This is because no scheme can maintain a pre-defined level of returns which are not linked in any way to market returns.  Just because the scheme is backed by a government does not make it viable!  The government backing may ensure safety today, but in the long run the scheme cannot maintain itself.  We are already seeing this in the US with social security benefits.  The social security scheme in the US is also in some sense a defined benefits scheme, wherein you are guaranteed to get a certain payout when you retire that is linked to your prior years income and investment into the Social Security Scheme.  However, the payout from social security is not necessarily linked to market returns.  Hence, the scheme is under tremendous pressure to fulfil its obligations to payout to the millions of Americans from the baby boomer generation, as they retire. 
Let us take a closer look at the PPF scheme in India and see if it has any similarities to the Ponzi scheme in the US from the early 1900s.  For starters the PPF interest rate is pre-defined by the government at the beginning of every year, and for decades has had no correlation to market returns.  The interest rate is in fact a political issue, and is decided by politicians, rather than economists.  Typically the interest rate is kept higher than prevailing market rates, ostensibly to encourage small savings, but also as a political ploy to please the voting populace.  This is similar to Mr.Ponzi with his promises of a higher rate of return than otherwise possible in the broader market.
Secondly, the PPF scheme is pretty opaque in terms of how the account is managed, where the money is invested and current status of the scheme.  Asset Management Companies (AMCs) in India are regulated by SEBI and are required to publish a detailed list of their financials every quarter, that include their investment portfolio, balance sheet, expense ratio, rate of return etc.  The PPF scheme on the other hand is nowhere near as transparent.  A recent audit of the EPF (Employee Provident Fund) scheme showed an excess of funds, that prompted the finance minister to increase the rate of return for the last financial year in the EPF scheme.  The "finding" of these excess funds, in itself, was hotly debated for the correctness of the financial audit.  Mr.Ponzi also did not maintain clear records, and it was impossible to fathom where the money deposited by his investors went. 
The PPF scheme depends on new investors coming in yearly with their fresh deposits to keep the scheme running.  When the collection began to drop for this financial year, the government stepped in and increased the interest rates to make the scheme more attractive.  This has been done in the past as well, to keep the inflow going.  The inflows into the PPF scheme are required, to fund various projects run by the government.  The payouts from the PPF scheme are guaranteed by the government, and are not dependent in any way on how the scheme may have performed in that financial year.  Again this is similar to Mr.Ponzi in that, he guaranteed his returns and they were not dependent in any way on how his business performed.
Now of course, Mr.Ponzi's scheme eventually failed when there was a run on his money.  When all the investors panicked at the same time, and asked for their money back, he was obviously not able to repay them and his business folded.  I do not expect this to happen with the PPF scheme, since it is backed by the Government of India.  If there is run on the PPF scheme, all they have to do is print new money and return it to the people, so there is zero risk of default.  In other words the scheme is simply too big to fail. This is similar to what has been happening all over the world economy from the big banks in the US, to entire countries in Europe.  After years of mis-management, these big banks or countries (effectively schemes) are considered too big to fail and bailed out by either their own governments or an international body (like in the case of the bailouts in Europe)  However, when you print/create money, you are actually defaulting in some sense, since the value of the money decreases.  So in effect, even though you will get your money back from the PPF scheme, it will have much less value than you are entitled to.  Mr.Ponzi also tried not to default his scheme by borrowing even more money (effectively what the government does, when it prints more money) but was not able to do it in time.  The PPF scheme on the other hand does not have this problem, and so it can continue to operate legally, borrowing as much money as needed (by printing more money) to make sure that no payouts are ever defaulted.
This has been a long series of posts, and I hope I have clearly articulated why a defined benefit scheme that guarantees a certain rate of return, that is higher than prevailing market rates, is no different from a Ponzi scheme.  This is true not just in India with the PPF, but also in more developed economies like the US which has Social Security.  (In the past the US also had company sponsored defined pension plans, that effectively destroyed several company finances.  Today all US companies have shifted to a 401K like approach, that promises market linked returns, and not pre-defined benefits)  In India, the NPS scheme is similar, in that it only promises market linked returns, nothing more, nothing less.  On the other hand PPF, EPF, and other such defined benefit schemes continue to operate as government sponsored Ponzi schemes.

2 comments:

  1. Nice research and thought process. I tried to write a comment which started growing too long, I converted it into a post in its own right.

    ReplyDelete
  2. Excellent Post! I explain this to people all the time but they think i am crazy. People belief in gov blindly. But gov cant get around simple rules of mathematics ie exponentials are unsustainable. The bigger PPF becomes the more unsustainable it becomes thus more risky. If we think of it India was close to bankruptcy in 1991 idea that such crisis cant happen again is silly. IF world economy tanks and indian exports collapse we will be in same situation again. With bigger economy and more money borrowed by gov since then its infact more likely than less likely and the probability will increase each successive year.

    ReplyDelete