Will New Bond Peg End Up 'Hurting The Old'?

Source : TODAY, Monday, September 17, 2007

(Picture) Manpower Minister, Mr Ng Eng Hen

IT IS designed to enhance the retirement nest egg, but if market conditions have their way, some economists and finance professionals wonder how re-pegging Central Provident Fund (CPF) interest rates to government bonds will help the older generation.

In a recent market weekly report, Citi economist Chua Hak Bin mapped out a scenario in which the younger generation may benefit, but the older generation may get lower returns than now, if their Special, Medisave and Retirement Accounts (SMRA) are pegged to a long-term bond.

The 10-year government bond has a current yield of 2.8 per cent compared to the SMRA's 4-per-cent guaranteed rate, he said. The Ordinary Account (OA) attracts an interest of 2.5 per cent.

Going by this, he calculated that younger individuals with a CPF account of $20,000 in their OA and $40,000 in SMRA would earn an effective interest rate (weighted average) of 3.7 per cent, or $120 more a year, compared to the current 3.5-per-cent effective rate.

The calculation includes the 1-percentage-point additional interest the Government plans to give on the first $60,000 in CPF accounts — up to $20,000 in the OA and the rest in the SMRA.

Still, an older cohort with the Minimum Sum of $99,600 in their SMRA and $20,000 in their OA would earn a lower 3.3 per cent, or $590 less a year, with the bond peg, Dr Chua calculated.

This is because a lower long-term bond yield could dominate the 1-percentage-point interest rate for those with larger sums in their SMRA.

Individuals who previously transferred their savings into the SMRA from the OA would also see the interest rate gap narrow substantially under the new peg.

"Not everybody will benefit. The younger generation benefits as they have only started to save and would most likely put their savings within the first $60,000. But if you are of the older generation who would have a larger proportion of your CPF savings in the SMRA, rates there are actually lower in the long run. Ironically, you are hurting the older generation you are trying to help," Dr Chua told Today.

A recession or financial crisis could also bring down the SMRA interest rate.

Manpower Minister Ng Eng Hen, who will explain in Parliament today how the Government will re-peg the CPF interest rates, said last month that the new SMRA rate will be lower initially, but should do better over time.

Economists have told Today they expect Singapore government bonds to be the reference point, while Society of Financial Service Professionals president Leong Sze Hian expects rates to be pegged to a composite benchmark of two or more indices, such as part Singapore bond index and part global bond index, to give higher returns.

Most, however, are sceptical about the chances of yields crossing the 4-per-cent threshold over time.

"I don't think pegging CPF to a government bond will get high rates above 4 per cent, at least until the end of 2008," said Mr Alvin Liew, former economist at UOB Treasury Research.

With long-term bond yields generally dependent on the outlook of the economy, which grew at 7.9 per cent last year, there are questions about whether Singapore's medium-term economic growth estimate of 4 to 6 per cent can sufficiently bump up yields.

Mr Leong added that bond rates fluctuate and depend on various factors like interest rates, expectations and default risks. "There is no basis for saying that the rate is going to be higher in the future. The fact is, nobody knows," he said.

Besides the impact on older folks, if rates are lower, it might cause a shortfall in Medisave accounts. Said Mr Liew: "In recent months, you have seen healthcare costs going up quite substantially in the Consumer Price Index. The lower-income group will be more affected by lower returns."

Sharing the same concerns, Member of Parliament Ong Kian Min said that, historically, CPF members have enjoyed guaranteed returns regardless of how the economy performs. This move marks a fundamental shift.

"Investing in bonds may subject CPF savings to lower rates. This can only be a good start provided the Government also considers, in future, investments other than bonds that may yield a higher return," he said.

These are some of the questions and suggestions the manpower minister will have to address today.