Cabinet approved an amendment to the Employees’ Provident Fund (EPF) Act in early August to ensure EPF members receive a minimum annual interest rate of nine percent from 2023 to 2026. The decision was based on the interest rates paid to EPF members in the past five years.
Under the Domestic Debt Optimisation program (DDO), the maturity of Treasury Bonds held by superannuation funds has been extended from 2027 to 2038. Interest rates on these bonds have a step-down coupon structure, initially at 12 percent until 2025 and then at nine percent until maturity.
The program is part of the broader reform efforts, including the International Monetary Fund’s (IMF) Extended Fund Facility Program (EFFP) that Sri Lanka is implementing to recover from its economic challenges.
Economist Prof. Prema-chandra Athukorala highlights certain concerns and issues related to the EPF’s involvement in the debt restructuring process in an article published in the East Asia Forum.
Athukorala said that the DDO program places a significant burden of debt restructuring on the EPF, as it is one of the institutions tasked with managing and holding a substantial amount of Government debt.
The approach is criticised for disproportionately affecting EPF members and salary owners, potentially impacting their future retirement incomes.
He said that the strategy of excluding the banking sector and certain forms of domestic debt from the DDO program is perceived as inequitable. It emphasises that this approach favours banks and certain creditors over others, potentially leading to social and political unrest due to perceived unfairness.
He also said that the selective exclusion of certain debt and institutions, such as the banking sector, might not align with the broader goals of safeguarding financial stability, which is crucial for long-term recovery and sustainable growth.
Ignoring the balance sheet fragility of commercial banks while placing a significant burden on the Central Bank could have unintended consequences for the overall financial system.
Loses
The proposed Domestic Debt Restructuring (DDR) program will slash 0.5 percent of the GDP from the annual returns to superannuation funds, including the EPF and the ETF, from 2023 to 2038 each year, economist Dhanusha Gihan Pathirana says.
The Central Bank expects a nine percent annual return for these funds and has provided GDP and debt projections. As GDP grows, the deductions will increase accordingly, Pathirana calculates.
Using the Central Bank’s projections, the 0.5 percent GDP reduction plus the nine percent loss from it will lead to a total loss of Rs. 3,779.2 billion from 2023 to 2038. This amount is more than the superannuation funds’ Treasury Bond holdings of Rs. 3,720.1 billion as of December 2022.
This will almost eliminate the annual return for the CBSL-managed funds, he says.
Meanwhile, private bondholders, including banks (35.6 percent), specialised banks (8.6 percent), corporations (1.8 percent), local individual investors (1.2 percent), insurance companies (3.6 percent), and primary dealers (3.4 percent), own the majority of high-interest-yielding Government Bonds, with 54.7 percent. In contrast, superannuation funds hold 42.7 percent of these bonds. Despite this, the Government’s proposed DDR plan places the entire burden on workers’ superannuation savings.
In 2022, high-interest-yielding bonds totalling Rs. 1,754.2 billion were issued. Of these, private bondholders purchased Rs. 1,324.8 billion (75.5 percent), while superannuation funds bought only Rs. 369.9 billion (21.1 percent).
The goal of DDR is to reduce the Government’s debt repayment costs, especially interest payments, which account for 93 percent of the 2023 budget deficit of Rs. 2.4 trillion.
Instead of targeting workers’ savings, the DDR should have focused on restructuring the bond portfolios of private entities that hold the majority of high-cost bonds issued in 2022, they said.
The approach unfairly burdens workers’ savings, while private bondholders benefit from declining market rates that boost bond prices. Market rates have dropped from over 30 percent to around 15 percent due to recent Central Bank policy rate cuts.
This indicates that restructuring the interest rates on bonds held by private entities wouldn’t harm the banking system, as market rates have already decreased.
The high fixed deposit rates offered by commercial banks in 2022 and early 2023 could be adjusted to align with the lowered rates on high-interest-yielding bonds held by the private sector, reflecting current market conditions.
Picking up the slack
Economic collapse in 2022, caused by years of financial profligacy, led to high interest rates. The proposed DDR plan unfairly burdens workers’ savings to cover the fallout caused by the elite while letting them profit, Pathirana said.
The findings indicate corporate tax evasion amounts to Rs. 904 billion. As Sri Lanka borrows to compensate, it provides a profitable avenue for entities evading taxes to invest in high-interest Government debt.
These entities also hold similar high-yielding bonds, which could offset their tax evasion without hurting honest contributors to superannuation funds.
Private bondholders face lower taxes on their interest income compared to superannuation funds. Fixing this tax imbalance would ease the Government’s debt repayment burden without changing.
Legal issues
President Ranil Wickremesinghe has emphasised that debt restructuring is a matter that falls under Parliament jurisdiction rather than the courts. He called on Opposition groups not to disrupt the restructuring process through legal actions.
The EPF said will not take up an offer to exchange rupee bonds until a tax is hiked on superannuation funds, lawyers said in a preliminary court hearing on domestic debt restructure.
The deadline to restructure the rupee debt of the EPF had been extended to August 28 from August 11, the Finance Ministry said.
“Following further feedback from Eligible Holders, in accordance with the terms of the Invitation to Exchange, the Republic today announces certain amendments to the timeline for the Invitation to Exchange,” the statement said.
Human Rights lawyer Swasthika Arulingam said that it’s unfair that 0.5 percent of the GDP burden has been placed on the superannuation funds.
“It’s only the superannuation funds, the EPF funds, which is basically the workers’ savings, retirement savings, which has been subjected to this domestic debt restructuring. The local bondholders have not been subjected to this domestic debt restructuring. So that is an obvious legal contradiction where in law you must have equal treatment,” she says.
The other issue she says is the Internal Revenue Act amendment. “The Government says they’re going to charge 30 percent tax on the profits of the superannuation funds, unless the selected funds, the EPF and ETF, take up the DDR package. Right now Parliament has only made a suggestion, so the Central Bank has to accept or make an offer.
If they accept the DDR package, then they won’t be charged this 30 percent. However, they will be charged 14 percent, which is what we have right now on the EPF and EDF accounts”.
Arulingam is also concerned about the tax system and its impact on low-income workers, particularly those in the plantation and apparel sectors.
She said that many of these workers earn relatively low salaries, typically around 20,000 to 50,000 rupees. Because of their low earnings, they don’t fall into the tax bracket. However, upon retirement, the Government is imposing a 30 percent tax on their earnings, which she says goes against the principles of the Constitution.
According to her perspective, this taxation approach appears to contradict the constitutional principle of equality and may also infringe on the legislative authority entrusted to Parliament by the people.
Desperate gambit
However, Economist Prof. Nihal Hennayake has a different angle to the grievances posed by activists. While the Colombo University academic agrees that this form of taxation is disproportionate, he said we should understand the situation which promoted the decision and not be alarmed at speculative market conditions.
He said that the IMF program is just temporary and Sri Lanka could revert by coming out mid-long term by expanding its tax bracket. “We still don’t have a comprehensive system of taxation.
We should include taxi drivers, lawyers, doctors, informal services and workers, artists and small retailers into this tax bracket”. He agrees that this cannot be done without hurting anyone. “Expanding the tax bracket is the only way,” Prof. Hennayake reiterated.
Meanwhile, one analyst suggested that the market is influenced by profit-taking and selling interest, particularly in the banking sector. The assumption was that favourable earnings reports could drive continuous interest in the market.
The Government’s initiative has stirred up various concerns and debates. While there are valid criticisms about the impact of the program on workers’ superannuation savings and the perceived inequities in burden sharing, it’s important to approach this situation with a comprehensive perspective.
The concerns raised by economists and legal experts highlight the need for fair treatment, transparency, and adherence to constitutional principles. The burden of debt restructuring should not disproportionately fall on workers’ savings, and the tax system should promote equality and not unfairly target low-income earners.
However, amidst these concerns, there is room for optimism. The Government’s reform efforts, including the DDO program, are part of a broader strategy to address the country’s economic challenges.
The program’s aim to reduce debt repayment costs, especially interest payments, is a step toward fiscal sustainability. As the economy stabilises and grows, there is potential for Sri Lanka to expand its tax base by implementing comprehensive tax reforms.
Prof. Hennayake’s perspective offers hope by emphasising that the IMF program is temporary and can pave the way for a more inclusive and expanded tax system. The focus on broadening the tax bracket to include various professions and sectors could not only generate revenue for the Government but also promote a fairer distribution of the tax burden.
This could ultimately lead to a more balanced approach to financing Government initiatives without disproportionately affecting any particular group.
Incorporating tax reforms that promote fairness and inclusivity will not only address the concerns surrounding the current program but also contribute to a stronger foundation for long-term economic recovery and growth.
By taking a holistic approach that considers the needs of all segments of society, the Government has the opportunity to create a more resilient and equitable economic future for Sri Lanka.