While discussing investments with a friend of mine, he suggested I look at PPF (Public Provident Fund). He told me that it’s the best investment with guaranteed returns and a maturity after 15 years. Moreover the investments, as well as returns, are tax exempt. Before investing, I decided to research PPF in detail and here are my observations.
What is Public Provident Fund (PPF)?
Briefly, it is a scheme wherein a person can invest money for the long term (15 years) at a rate determined by government, compounded annually.
People mostly invest in PPF as a fund secured for life-after-retirement. The main purpose of PPF investment is to meet one’s long term goals, such as children’s higher education or marriage. Mostly businessmen invest in this scheme, for two logical reasons.
- They don’t have a PF account like salaried employees, to get pension after retirement.
- PPF doesn’t come under decree of court, so even if all their assets are liquidated to meet liabilities, this investment is still safe.
Where does the corpus go?
Many of us invest in PPF, but have we ever thought where does the money collected go? If we consider government as a ‘company’ then PPF is simply a debt given to this company. For the government to honour its obligation, we are relying on the government’s ability to pay back the maturity amount after 15 years. With the recent concerns that arose in the US social security funds, it is prudent to analyse this investment option carefully.
Is the investment worthwhile? Is the government capable of giving the promised return? Or should you invest somewhere else? How safe is our investment in PPF?
Like any other company, we should look at the revenue and expenditure of the government. Let us first see how the government makes use of money. Government spends the PPF corpus on infrastructural development, subsidies given, education schemes, security/defence expenditure, health programs, social welfare schemes, interest payment on foreign loans, repaying various loans and borrowings taken, etc.
On the revenue side, the government earns from taxes (direct and indirect), various duties, money raised by government loans, interest received, external borrowing, and disinvestment in PSU etc. But tax revenue is not enough to meet its corresponding expenditure on infrastructure and subsidy etc. This difference is financed by increased borrowing. These borrowings include foreign loans and other government loans (including Govt. bonds, PPF corpus etc.)
This ‘company’/government is borrowing more to pay back the obligation of previous borrowings. This means, the government is borrowing more through PPF to payback maturing PPF and to meet the infrastructural developments which cannot be met with tax receipts. Imagine if new borrowing to this ‘company’ is stopped or restricted, then the maturing obligation will be under threat. This is close to what is going on in the US currently.
The US government is running with high debt and one-third of it is owed to the citizen of the country in terms of social security and other trust funds. The money with trust funds was lent to the US government at a ‘risk-free’ rate over the years. Because of the US government’s reckless spending, now it is facing a severe problem in meeting its debt obligations. This almost led to a default by Government, followed by the recent downgrade in rating. As a result, new borrowings have become more expensive and the best option available is to increase taxes, thereby increasing the burden on citizens eventually.
With increased expenditure financed by increased borrowing, will the government be able to payback the maturity amount, after 15 years? Is this kind of financing sustainable in the long run? Would you consider lending to such a ‘company’?
In our quest to know about safety of PPF investments, we contacted a few tax consultants. Mr. R. N. Lakhotia (New Delhi) says, “Government will be in position to pay it back (PPF) after maturity.” Mr. Vijay Thorat (Pune) also has same view and says, “The condition in India is good and I don’t see any problem arising on safety of PPF Investment.”
Though our government is not involved in reckless and risky investment (which U.S government was) investors must consider that risk changes as Governments change. Also, if this can happen with world’s most stable economy (US had AAA rating prior to this!!!!) one can imagine what will happen if something was to go wrong with our economy.
Ultimately this investment doesn’t seem risk-free. Moreover there are certain concerns which make PPF a less attractive investment.
1. Risk of changing interest rate
Government can change rate of interest offered on PPF investments and there is nothing one can do about this. Initially rate of interest was 12% which dropped to 11%, then to 9.5% and now it is 8%. Going forward, the Government would be compelled to continue this trend over the long term, as the India moves towards becoming developed economy. Mr. Lakhotia says, “PPF interest rate is unlikely to come down any further.” But Mr. M.G. Kshirsagar, a practicing C.A. from Pune, believes that with tax exemptions and liquidity constraints, PPF seems like an expensive source of funds for the Government. Thus, the interest rate might reduce in future.
2. Is it really a tax-free return?
Common notion says that the government can pay back money even in bad situations, just by printing notes. But it isn’t that simple, because this will increase inflation thereby eating your returns away. Moreover RBI will not be comfortable with increased inflation.
Even otherwise, inflation in India is almost in double digits. Indian economy is growing and it will certainly be accompanied by inflation. Mr. Kshirsagar says, “PPF interest rate doesn’t have the capacity to absorb inflation in India.” So, will there be any returns in an investor’s hand, after inflation is fed?!! Practically, this might even eat away investor’s tax-exemption benefits.
3. Will your money grow?
By only investing in PPF, you are missing growth story of century, which is India. Our country is poised to grow tremendously in the next decade and this growth will be reflected in stock markets. Historically speaking, investing in a fundamentally strong company at an attractive price can give returns ranging from 15-20% per year with low risk. This means if you invest Rs. 10,000 in PPF (at 8%), it will be Rs. 21,589 after 10 years, but the same investment in equity market (at 15%) will give you a return Rs. 40,455. So Rs. 18,866 is potentially the cost of opportunity forgone. Mr. Kshirsagar also agrees that investment in SIP will give more returns than PPF.
With the government running in deficit, and with inflationary pressures, one needs to think how worthwhile is it to park your hard-earned money with Government for the long-term?
Do you really believe in bureaucrats and politicians managing your money? Will the government be able to pay interest rate of 8% and the principal back at the end of period? Even if it does, can this return beat inflation?
Write in with your views….
Disclaimer: This publication has been prepared solely for information purpose and does not constitute a solicitation to any person to buy or sell a security. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations or needs of an individual client or a corporate/s or any entity/ies. The person should use his/her own judgment while taking investment decisions.
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