Longer Term CPF Funds already Get Higher Interest Rate
- TODAY 03 February 2007
Please refer to the commentary "Is the CPF interest rate out of date?" by Mr Alan Greene (TODAY, 29 Jan 2007), who suggested that the CPF Board should benchmark its interest rate to longer-term money, given the long-term nature of pension funds.
2. The bulk of CPF savings today are in the Ordinary Account (OA) which can be withdrawn on demand at members' discretion for housing, investment and education purposes. This is why the OA formula is pegged to a weighted average of the savings account (20%) and 1 year fixed deposit (80%) rates of the major local banks, but subject to a minimum of 2.5% p.a. The latest OA formula derives an interest rate of 0.74%. On this basis, CPF Board is already paying a much higher rate at 2.5%.
3. Mr Greene's idea of paying a higher interest rate for longer term funds is already being applied to savings in the Medisave, Special and Retirement Accounts which have tighter withdrawal rules and are of a longer tenure. They earn an interest premium of 1.5% above the OA rate. CPF members who wish to enjoy this higher interest rate of 4% per annum have the option of transferring savings from their OA to the Special Account. CPF members may also invest their OA savings in market instruments through the CPF Investment Scheme to take advantage of higher market rates.
It is good to hear the politicians engaging with focus groups on GST rises, increasing the CPF levy on employers and targeting support for the less fortunate. However, a workable balance will be difficult to achieve while there is more than $50 billion of mis-priced money in the economy, in the form of CPF Ordinary Account savings.
The computed CPF rate is based on an inappropriate blend of interest rates. Acceptable in the 1980s and 1990s when the local banks needed support and the financial markets were under-developed, the formula is past its sell-by date. Singapore's money markets have globalised, and there are now long-term financial assets available to match the duration requirement of retirement fund investments. Based on the average of the one-year fixed deposit rates and the savings rates offered by the four local banks, the formula was last adjusted in 1999, when the calculation was weighted towards the one-year rate.Since then, we have lost a local bank and money markets in Singapore enjoy liquidity up to five years and beyond.
Local banks are probably very happy with the situation. The distortion allows them to keep deposit rates down and not only make an enhanced interest spread; it also encourages CPF members to dabble in bank-arranged CPF investment schemes, thus supporting the banks' fee income. The irony of the situation was rammed home to me recently when one bank offered a rate of 3.15 per cent on one-year fixed deposits using CPF money.
For the purposes of the CPF rate calculation, this bank's savings rate is 0.3 per cent and its one-year fixed deposit rate is 0.825 per cent. The current computed rate is 0.74 per cent, and so, the actual rate applied is the legislated minimum of 2.5 per cent. Outside the cosy world of the local banks, there are other banks giving 2 per cent or more on Internet savings accounts, and some, 3 per cent on one-year fixed deposits. However, given the long-term nature of pension funds, the CPF should be benchmarking its rate to longer-term money.
For example, a simple average of the 1-, 3-, 5- and 10-year interbank swap rates quoted on Jan 26 is 3.483 per cent. If 30 basis points is deducted from this number to reflect the credit risk differential between the Government and the banks, then we still have some 3.18 per cent. This is a more realistic rate for CPF funds — well above the 2.5 per cent currently paid. So, if the $50 billion of money is properly priced, what might happen?
The froth would come off the property markets, CPF savings would increase at a greater rate and the economy would benefit from less emphasis on fixed asset creation and more on consumption. GST receipts would potentially rise and diminish the need for the 40-per-cent increase in the tax. CPF balances would rise, coupled with less risk of employers reducing their workforces. The less well-off would benefit because the level of the regressive GST levy would be lower than is currently envisaged. The CPF is not broken, just in need of some upgrading.
The writer is a financial analyst and CPF member.