Is the CPF a cheap source of funds for the govt?

When asked by Straits Times (29 Sep 2007) whether the govt has been using the CPF as a cheap source of funds, Tharman replied that this is “wrong and plainly misleading”. He says the govt can borrow more cheaply from the market, at 1.7% on average over the last 10 years for one-year treasury bills (instead of 2.5% for CPF ordinary account) and market rate (3%) for 10 year bonds (instead of 4% for CPF special account).

Firstly, it is indeed wrong and plainly misleading for Tharman to quote the figure of 1.7% over the last 10 years. The last 10 years have seen three of the most difficult setbacks to our economy – the Asian financial crisis in 1997, 911 in 2001 and SARS in 2003. The interest rate over this difficult period would be correspondingly lower than the more prosperous times before that.

If we wish to determine the appropriate return for our CPF funds, we should take into consideration market interest rates stretching all the way back to 1955 when CPF first started. Since we can only obtain interest rates as far back as 1988 from MAS’s website, we can calculate the average interest rate from 1988 to 2007 to be 2.1%. This is much higher than the misleading 1.7% that Tharman quoted.

Secondly, we need to also ask ourselves is it appropriate for Tharman to compare the CPF ordinary account to one-year treasury bills? Do CPF members have the flexibility of cashing out their CPF ordinary accounts every year? Obviously no. Only married couples draw out their ordinary account to pay for their HDBs. But that depends on when they get married and if we say that on average, CPF members get married 5 years after they start work, that means their money would be locked in the CPF for at least 5 years. In other words, the CPF ordinary account should at least be compared to a 5-year bond which commands higher interest than a 1-year treasury bill. Bear in mind, we have not even considered those people who remain single and can only purchase a flat at the age of 35 or who never get to touch their CPF until 55 years of age.

Guess what is the average market interest rate for 5-year bonds from 1988 to 2007? 3.5%! So all this while, when they should’ve given us 3.5%, they have only been giving us 2.5% – a short change of 1%.

What does that short change of 1% amount to? Given that the entire CPF sum is $100 billion, the short change amounts to $1 billion annually, more than sufficient to pay for the $2.8 billion grants and subsidies given out by the govt over the last 5 years (ST, 29 Sep 2007).

So you see? The govt has been giving out money that is actually saved from paying us less interest than we deserve. They have been using CPF as cheap funds. How cheap exactly? 1% cheap which they are finally giving back to us.

It is also wrong for Tharman to compare the CPF Special account, which remains locked up for at least 30 years to 10-year bonds. Experts interviewed by ST argued in favour of Tharman saying that the government doesn’t issue 30-year bonds so the nearest duration for comparison would be 10-year bonds. Furthermore they say that since the rate difference between 10 and 30 year bonds in the US is so negligible, it justifies equating a 30-year bond’s interest to a 10-year bond’s interest.

This explanation is not entirely satisfactory because we know intuitively that longer duration deposits fetch higher interest rates than shorter ones. If the market doesn’t pay an equitable premium for 30-year bonds over 10-year bonds, why should people be willing to lock up their money for 30 years when they can get the same rate of return for just 10 years?