The Employees’ Provident Fund Organisation (EPFO) is studying the possibility of establishing a special Interest Stabilisation Reserve (ISR) amounting to 25,000 crore rupees. This reserve is intended to protect the annual interest payments for nearly 30 million fund members from instability caused by corporate bond defaults and losses during forced asset exits.
Officials stated that EPFO and the government aim to ensure a stable regime for their subscribers, avoiding sharp increases or decreases in rates driven by market conditions or defaults.
Under current regulations, credit losses and exit losses arising from downgrades of securities directly affect the EPFO's interest account and reduce the annual rate for participants.
As reported to TOI, the EPFO Investment Committee (IC) discussed in detail on Thursday a proposal submitted by IIM Kozhikode. This proposal examined the feasibility of creating an ISR.
The report was sent to a high-level committee established to analyze the agency's investment structure and recognize non-performing investments. It proposed gradually building up the stabilization reserve using capital gains from ETF surpluses and excess interest income, investing the funds exclusively in liquid Government Securities (G-Secs) to ensure absolute capital preservation, sovereign backing, immediate liquidity, and risk-free returns.
This reserve would not only protect subscribers but also support an active asset exit policy, allowing portfolio managers to conduct disciplined multi-year exits from troubled assets without hesitation.
The study took into account the current realities of India's over-the-counter (OTC) corporate bond market, which remains shallow and illiquid. When institutional holders like EPFO are forced to sell distressed assets, low market depth leads to significant losses.
Historically, EPFO has heavily relied on capital gains from ETF stocks to offset credit stress. However, the report noted that market volatility in the 2019-20 financial year coincided with major credit events, such as the IL&FS default, revealing a critical vulnerability. The document emphasized: 'Credit stress and stock market crashes correlate strongly. Relying solely on ETF gains is risky; an autonomous preventive reserve is a structural necessity.'
The study assessed scenarios of absolute worst-case write-offs across the entire portfolio considering available ETF gains, determining a cumulative base deficit of approximately 23,837 crore rupees. Consequently, the report recommends formalizing an ISR fund of 25,000 crore rupees to account for incomplete market data and provide a reliable buffer.
Historical data modeling showed that a reserve of 25,000 crore rupees successfully absorbs annual deficits and stabilizes declared interest rates over typical economic cycles, based on a simulation of portfolio returns from 2010-11 to 2023-24. The only exception was 2019-20, when the portfolio deficit surged to 55,640 crore rupees, leading to a deep draw from the reserve. Nevertheless, the study noted that the subsequent recovery in investment performance in later years suggests that such a deficit was likely temporary. In such a case, EPFO could cover the temporary deficit through a short-term advance or loan, which could subsequently be repaid from future surpluses generated in recovery years.