13 March 2014

CPF Sense And Nonsense Part Two

This is the second part of a two-part article.

CPF interest rate is too low
The interest rate on CPF balances is too low, and many people want a higher interest rate. But is it realistic?

Budget and balance of payments
CPF moneys are invested in special issues of Government securities. The interest rate of these, and other, Government securities is determined by several factors.

The Government budget is usually a surplus. The surplus for the three years FY2011 to FY2013 (ending 31 March 2014) was $13.7 billion. Also, this surplus was or will be achieved after endowment and trust funds are topped up by $18.5 billion, which means that although this amount is expended according to Government accounting, most of it is not spent immediately and ends up being invested in Government securities. Similarly, of the $8.0 billion transferred to the Pioneer Generation Fund, only about half of it will be used over the next 10 years. The result is that the Government is flush with cash and does not need to borrow.

Our country's balance of payments is usually a surplus i.e., there is a net inflow of funds into Singapore. The overall balance was $134 billion over the past four (calendar) years.

Together, these two factors act to depress local interest rates. For example, the 10-year Government bond yield is around 2.5 per cent.

Additional CPF interest
Although the interest rate on our Ordinary Accounts is an unexciting 2.5 per cent per annum, CPF balances in other CPF sub-accounts earn higher interest rates.

The interest on our Special and Medisave Accounts is 4.0 per cent from 1 January to 31 March 2014, and has been so for some time.

The interest on our Retirement Account is 4.0 per cent from 1 January to 31 December 2014, and has been so for some time.

An additional interest of 1.0 per cent is paid on the first $60,000 of a member's combined balances, with up to $20,000 from the Ordinary Account.

CPF investment scheme
There is nothing to prevent anyone who thinks that he can get higher investment returns by investing his CPF moneys in CPF approved mutual funds. Yet in 2012, only about $2.2 billion was withdrawn (net) for investment compared to total net contributions to CPF accounts of $24.7 billion. Why? Possibly a combination of lack of information, inertia and risk aversion.

CPF interest rate should approximate Temasek's / GIC's rate of return
The argument is that, since the moneys that Temasek and/or Government of Singapore Investment Corporation ("GIC") are derived from our CPF accounts, we should be paid the rate of return that Temasek and GIC have been achieving.

Banks don't give depositors their lending rate
When we deposit our money in a bank, we don't (and can't) demand that the bank gives us a deposit rate equal to its gross or net lending rate.

Long-term investment
Temasek and GIC, being sovereign wealth funds, operate like private equity funds, which make long-term investments.

Every employed person has moneys flowing into his CPF account regularly (mostly monthly) and moneys flowing out of his CPF account regularly (monthly in some cases) for his mortgage servicing, Medishield premiums, medical expenses etc. Individually, few people are certain what amounts in their respective CPF accounts are moneys that they will not use over, say, the next ten years or more, to qualify for a long-term investment rate.

CPF Board, as an aggregator of our CPF moneys, however, can estimate the amount of funds it can commit over, say, the next ten years or more, to qualify for a long-term investment rate, and it does give CPF members the full benefit of the long-term investment rate (less operating and other expenses).

Negative return
Temasek discloses to the public its 5-year compounded annual rate of return, not its annual rate of return. It is likely that it recorded a loss in 2008 during the financial crisis. Are we prepared to accept a negative rate of return on our moneys — meaning that our CPF balances will shrink, excluding the effect of net contributions — even if it is a one-off event, or will we clamour for protection or preservation of our CPF moneys?

Equitable benefit
The net investment return contribution was $7.9 billion in the FY2013 revised budget and is forecast to be $8.1 billion in the FY2014 budget.

After taking into account the net investment return contribution, the overall budget surplus was $3.9 billion in FY2013 and a deficit of $1.2 billion is forecast in FY2014.

Without the benefit of the net investment return contribution, there would have been a budget deficit in FY2013 and a bigger deficit in FY2014.

This is what will happen if, instead of using (part of) the State's net investment return in the Budget, it is credited to CPF members' accounts.

Furthermore, which is more equitable or socially beneficial: credit the net investment return to CPF members' accounts, which would benefit those with larger CPF balances, or use the net investment return in the Budget?

HDB mortgage rate
HDB's mortgage rate is set at 10 percentage points (i.e., 0.1 per cent) above the CPF interest rate. If we accept the argument that the CPF interest rate is artificially low, it follows that CPF members whose CPF balances are higher than their HDB mortgage balances are subsidising CPF members whose CPF balances are lower than their HDB mortgage balances. If the CPF interest rate is raised above the current 2.5 per cent, the HDB mortgage rate will have to be raised correspondingly higher; otherwise, who funds the difference? Are people with HDB mortgages — especially those whose HDB mortgage balances are much higher than their CPF balances — prepared to accept this?

Some people may argue that the CPF interest rate and the HDB mortgage rate need not be linked. Irrespective of the merits of that argument, it is not logical for the CPF interest rate to be higher than the HDB mortgage rate; otherwise, tax payers end up subsidising either or both.

The Government can't repay CPF moneys
CPF moneys are invested in Government securities and put to use, mostly in medium- to long-term investments, to generate returns.

If CPF Board is required to pay out the $233 billion in net assets (as at 31 December 2012) at short notice, it will be unable to do so. Neither would it be able to realise the fair value of the Government securities that it holds. This is a predicament that all financial institutions face.

But that is not the same as alleging that CPF Board, Monetary Authority of Singapore or the Government (i.e., the State) is insolvent or potentially insolvent.

1 comment:

  1. 1. on people investing their cpf money themselves.
    first 20k cannot invest. after that only 35% in ordinary account. special account has limited choices. fund in Singapore has very high overhead. Investing by individual is disadvantage as compared to huge fund who always has a line of investment asking for their involvement in a favorable terms.
    2. not distributing money make from cpf money but used it in budget is additional tax to those who has more money in cpf.
    3. people who has money in cpf has no relationship with people who loan money for buying house. why should one subsidized the other?