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Attractive CPF Returns or IPS Naivety?

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The Institute of Policy Studies (IPS) research on CPF returns reported by the Straits Times on 9 December 2014 makes an interesting read. That is if research shaped to please the government is your cup of tea. It makes the following claims

  • Within the CPF, the Ordinary Account currently gives a guaranteed interest of 2.5 or 3.5% for balances up to $20,000. This is significantly higher than deposit rates offered by the banks.
  • Over the next 20 years, CPF could generate 5.7 per cent a year, IPS said. This is based on certain assumptions such as rising interest rates.

And what are those assumptions? The writer rebuts them later in the article.

CPF a bank deposit?

The IPS ought to know the ability to withdraw from the Ordinary Account for mortgage payments and education does not make it equivalent to a bank deposit especially since one is required to return the withdrawn funds. Savings contributed into the OA is equivalent to a 10 year bond, not a 1 year bank deposit. The 1.4% the research stated as additional return over bank deposit is sheer nonsense. The OA rate should be compared to the 10 year bond yield.

Real Rates of Return

But of course nominal interest rates does not mean much without accounting for inflation, a surprising omission by the IPS. Here are the average real yields over the past 10 years using 10 year bond yields compared to the OA rate, both adjusted by inflation. Please note that peers had lower rates of GDP growth. This paints CPF’s real OA rate of return in even worst light given the strong GDP growth over the period.

Figure Comparative Real Rate of Return

Returns rise to 5.7% but…….

The most fallacious part of the research was the claim that returns could rise to 5.7% based on certain assumptions. So let us take them apart.

“Singapore and global inflation to remain modest over time at about 2.5 per cent. Singapore cash rates, or short-term deposit rates, to increase to 4 per cent over 10 years, from current near-zero levels.”

Currently inflation is at 2.5% but interest rates are close to zero. This is obviously abnormal, caused by the MAS’ exchange rate policy importing low interest rates from the West, resulting in elevated cost of living and runaway real estate prices. A normalisation of interest rates can be expected but deposit rates can rise to the inflation rate or marginally higher at best. For deposit rates to rise to 4% as it is assumed, then inflation is expected to rise to at least 3.5%. So this assumption is wrong. If deposit rate is at 4% inflation is going to be higher than 2.5%.

“Singapore Government bond yields to increase to 5.3% over 10 years, from current 2.2%”

Like deposit rates, bond yields cannot rise to 5.3% if inflation “remain modest over time at about 2.5%”. A rise in bond yields like the rise in deposit rates signal an expectation that inflation will increase from 2.5%. However, even if bond yields are to rise to 5.3% on expectation of higher inflation, there is no guarantee that CPF rates will adjust to 5.7% as the research over-optimistically forecasts. Out of the past 18 years, only in 4 years was the OA Rate higher than 10 year bond yields, observed from the chart below.

Figure 10y Bond Yields minus OA Rate

The government adjust CPF rates at its sole discretion. It likes to tell the public when OA rates are higher than bond yields but remained silent when OA rates had mostly been below bond yields. Therefore, the IPS may assume 10year bond yield rise to 5.3% but that does not mean the government will adjust CPF rates to match the rise in bond yields.

CPF Returns are political

The deepest flaw in the IPS research is that it failed to consider the political risk of CPF rates being set by government administrative fiat. Politics ensured CPF returns are unlikely to deliver as the IPS expected. This is because the government administrative fiat over CPF rates is the tool of financial repression, sending excess returns earned by GIC and MAS into the SG reserves. That alone should make any thinking person wary of such rosy forecasts. The political equation is the reason why CPF is far from a risk-free investment.

Chris K

* Chris K holds a senior position in a global financial centre bigger than Singapore. He writes mostly on economic and financial matters to highlight misconceptions of economic policy in Singapore.

For me, the main problem for the IPS research is that they have deliberately obfuscate the function of the CPF, which is retirement adequacy. If CPF is about how good a car is, why this Singapore car is so good, what they have done is limited the discussion to the headlights. As though headlights itself define a car. They talked in and out of the headlights, circumference and diameter, how comparatively beautiful it is, yet, when the car starts it stalls.

It was a non starter to begin. The CPF conundrum overlaps the philosophy of economics, politics and the social. It is more than rates. It is how CPF cannot cope with retirement adequacy.

This government is unable to communicate. If the government cannot communicate honestly, the trust gap gets wider. If a government cannot communicate it fails.

I remember a story I read. The Smokejumpers are elite wildland firefighters. They are parachuted into the wild fire to try to prevent it moving into the suburbia. In fact, the smokejumpers is the forerunner of the parachute regiments of WW2.

During one of these wildfires, a group of them were surrounded as the wind conspired against them. The leader who was disliked and distrusted told them to dig and then unfurled their foil-lined, heat-resistant tarps and to cover themselves- “deploying the shelter”. But because they didnt trust him they disregard him. He, the leader was the only one that lived.

“Deploying the shelter” is a last ditched effort to save themselves. And even then you may not survive.

It doesnt matter if you are right. If you are distrusted you endanger the lives of your people. The political risk that @ Chris K talked about is alot more real than it seems. In a ‘trust gap’ situation, administrative fiat is dictatorial, and with political polarization, social chasms will deteriorate further.

Nations like sports team, dont just run on economics, it runs on morale, trust and social cohesion.




One thought on “Attractive CPF Returns or IPS Naivety?

  1. Pingback: Daily SG: 16 Dec 2014 | The Singapore Daily

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