17 June 2014

Pitfalls Of Raising CPF Interest Rate

Some people are demanding that the Government raise the interest rate on their moneys in their Central Provident Fund ("CPF") accounts.

They say that Temasek Holdings, which together with Government of Singapore Investment Corporation ("GIC") and Monetary Authority of Singapore ("MAS") invests on behalf of the State, achieved 8.86 per cent return to its shareholder for the financial year ended 31 March 2013 and 13 per cent compound return to its shareholder for the 10 years ended 31 March 2013.

Currently, the CPF interest rate is 2.5 per cent for the Ordinary Account ("OA"), 4.0 per cent for the Special, Retirement and Medisave Accounts, and an additional 1.0 per cent for the first $60,000 of a member's combined balances, with up to $20,000 from the OA.

What are the consequences of raising the CPF interest rate?

Benefits Skewed
A higher CPF interest rate will, in general, benefit members with higher CPF balances more than members with lower CPF balances.

Members with higher CPF balances typically are people (i) whose monthly ordinary wages exceed $5,000 (the upper limit for CPF contributions) and/or earn high additional wages; and/or (ii) who are near retirement.

Members with lower CPF balances typically are people (i) whose monthly ordinary wages and/or additional wages are low; (ii) who are self employed and contribute to their Medisave accounts by law; and/or (iii) who are young.

HDB mortgage rate
HDB's mortgage rate is set at 10 percentage points (i.e., 0.1 per cent) above the CPF OA interest rate. If the CPF OA interest rate is raised, the HDB mortgage rate has to be raised in tandem.

Some people argue that the HDB mortgage rate does not have to increase in tandem with the CPF OA rate. However, this is disingenuous and illogical because money is fungible and money lent to HDB mortgagors could have been invested to produce the same returns that CPF members are demanding.

If the CPF OA interest rate is increased but the HDB mortgage rate is not increased correspondingly, the State will effectively be subsidising the HDB mortgage rate.

If both the CPF OA interest rate and the HDB mortgage rate are raised:

▪ It disadvantages CPF members whose CPF OA balances are lower than their HDB mortgage balances. These are mostly the young households, the self-employed and the poor.

▪ It benefits CPF members whose CPF OA balances are higher than their HDB mortgage balances. These are mostly the rich and some (but not all) elderly households.

Are HDB mortgagors prepared to accept a higher mortgage rate if the CPF OA interest rate is increased?

Budget
The Constitution allows the Government to use up to 50 per cent of the net investment returns contribution ("NIRC") from Temasek, GIC and MAS (with effect from 1 April 2009).

Raising the CPF interest rate will require either the NIRC to be reduced or Government expenditure to be increased (due to higher interest expense on special issues of Government securities held by CPF Board). Either way, the Government will have to raise revenues, most likely by raising the GST rate.

As at 31 December 2012, CPF Board held $228 billion in special issues of Government securities (including advance deposits). Raising the CPF interest rate by one percentage point requires $2.28 billion.

To put this in perspective, the NIRC was $7.9 billion in the FY2013 revised budget and $8.1 billion in the FY2014 budget.

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

In this zero-sum matter, which is more equitable or socially beneficial: raising the CPF interest rate, which would benefit CPF members especially those with larger CPF balances, or using the NIRC in the Budget?

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