Use GIC returns as component in CPF OA rate: NUS prof

Singapore

THE Singapore government can consider partially pegging the interest rate paid by the Central Provident Fund (CPF) Ordinary Account (OA) to returns generated by sovereign wealth fund GIC, an academic has suggested.

National University of Singapore (NUS) economics associate professor Chia Ngee Choon acknowledged that GIC returns are already distributed to Singaporeans indirectly through, for example, Budget top-ups to CPF accounts.

But linking GIC to the CPF OA interest rate allows for a more direct channel for Singaporeans to enjoy GIC returns should the fund do well, she said. "We don't want to miss the opportunity of having a higher rate," she said. "We can still keep the 2.5 per cent guarantee."

Prof Chia, who is also co-director of social issues research centre Next Age Institute, made the suggestion in an academic symposium on social security at NUS on Tuesday. She will be publishing the idea, among others, in a coming book on CPF.

Currently, OA monies earn either the legislated minimum interest of 2.5 per cent per annum, or the three-month average of major local banks' interest rates, whichever is higher.

The legislated floor rate is currently paid out as bank interest rates have been low, with the relevant three-month average at 0.21 per cent from August to October 2015.

This rate is derived using 80 per cent of the 12-month fixed deposit rate of DBS, UOB and OCBC, which stood at 0.25 per cent, and 20 per cent of the savings interest rate of the three banks, which stood at 0.05 per cent.

A low-interest-rate environment has caused bank interest rates to be near zero since the global financial crisis of 2008-9.

Meanwhile, GIC has achieved a 20-year annualised real rate of return of 4.9 per cent for the financial year ended March 31, 2015. In US dollar terms, including the effect of inflation, GIC's portfolio generated an annualised nominal return of 6.1 per cent over the 20 years ended March 31, 2015.

Prof Chia said she has not done a study on how much CPF OA returns can be boosted with a change in the formula - if returns will indeed increase. Nor did she say what proportion of the formula should comprise GIC's returns.

Yet a change in the formula, which has been around in two different forms since 1986, is overdue given a different macroeconomic environment, she said.

To get higher returns on CPF, Prof Chia also suggested that Singaporeans can transfer excess money from the OA, which is used for housing, to the Special Account (SA), which is used for retirement and which generally pays a higher interest rate of 4-5 per cent a year.

The CPF Board can encourage Singaporeans to monitor their OA and SA account balances more actively through sending text messages or e-mail reminders, she said.

However, people might be wary of transferring OA monies to the SA, because the transfer is irreversible. Those who transferred might want to use the money to purchase a more expensive house, she said.

She thus suggests introducing some flexibility to transfer money from the SA back to the OA, perhaps with a penalty or administrative fee.

Prof Chia was giving her suggestions on CPF at a time when a government-appointed panel is expected in the coming months to recommend how CPF members can achieve inflation-linked, as well as higher, returns.

The Singapore Business Federation (SBF) suggested last week that GIC use CPF monies to invest in the local stock market, where a number of stocks are trading at depressed valuations. While some market participants welcomed the idea, others have said that GIC and CPF play different roles and should not be linked.

The government issues special non-tradeable bonds that the CPF Board invests in. GIC puts these proceeds together with proceeds from other areas, like normal bond issuances, budget surpluses and land sales, to invest as a single pool. Part of GIC's investment returns goes towards supplementing Singapore's annual Budget, which is allocated to investments such as in healthcare, education, and infrastructure.

Asked about Prof Chia's idea, Joseph Cherian, practice professor of finance at NUS Business School, said that he prefers not to tinker with the current system. Risk-adjusted returns should not be weighted together with safe returns, he said.

American economist Peter Diamond of the Massachusetts Institute of Technology (MIT) said the issue is not so much a question of interest rates, but about where the government should allocate what is essentially a subsidy.

"When you think about changing the formula, perhaps open up risk options, that doesn't mean the subsidy has to go away . . . you can move it around to other places as part of a reform plan," he said.

Prof Diamond, who won the Nobel prize in economic sciences in 2010, gave a speech at the symposium comparing pension schemes in Chile, Sweden and the US.

In Sweden, there is a "premium pension system" financed by a 2.5 per cent payroll tax, where workers could choose from a broad range of funds.

However, enthusiasm for making choices died out, even as the government-run default option gained popularity. Government involvement had lowered costs, even for privately managed funds it competes with, he said.

For the default option, assets are 100 per cent invested in equities before age 55. Assets are thereafter switched progressively to fixed income until age 75, when two-thirds of assets ends up in fixed income and one-third in equities.

Prof Diamond noted that while just a third of Swedish investors chose the default plan initially in 2000, 98.5 per cent of them did so by 2011.