Investments Crowded Out?

Source : TODAY, Tuesday, August 28, 2007

CPF interest rate hike could hurt financial institutions: Analysts

THE Government’s decision to increase the Central Provident Fund (CPF) interest rate from 2.5 per cent to 3.5 per cent for the first $20,000 in the Ordinary Account (OA) and up to $60,000 on all other accounts may be good news for its members —but could be a cause of concern for private investments.

In a weekly report, Citi economists said the higher guaranteed rates of return “could crowd out investments in the CPF Investment Scheme (CPFIS) … hurting financial institutions currently offering units and insurance products under the scheme”.

As of the end of June, about $113.5 billion was available for investment under CPFIS, but only 28 per cent or $32.1 billion from the CPF-OA and Special Account (SA) was used.

Of the amount, nearly 68 per cent is in insurance products and 16 per cent in unit trusts.

Changes to the CPF have led many research houses to look at the impact on the financial sector.

According to Citi, experts said the new scheme, which redistributes “subsidies” from the upper middle class and above to the lowerincome segments, ironically could also hurt older Singaporeans who have built up larger balances —mostly over and above their OAs — in their Special, Medisave and Retirement Accounts (SMRA).

The Government will peg the rate for those accounts to the yield on a long bond.

Now, CPF pays 4 per cent on SMRA, and it will be 30 per cent less based on the 2.8 per cent yielded by the 10-year bond, Citi said.

Thus, a CPF account with $20,000 in OA and $40,000 in SMRA would earn an effective interest rate of 3.7 per cent or about $120 higher under the new scheme, compared to the existing 3.5 per cent.

But for members who have the Minimum Sum of $99,600 in their SMRA and $20,000 in the OA, the effective interest rate would be only 3.3 per cent, or $590 less under the new scheme.

Thus, while the higher rate may encourage account holders to leave their money in their CPF, the lower SMRA rates could spur them to seek market investments to offset the lower returns on those accounts, especially during recessionary conditions when bond yields typically fall.