1. For Internal Use Only – Not For External Distribution © 2015 CRISIL Ltd. All rights reserved. 1 Opportunities and Challenges of Equity investments in Provident Funds July 31, 2015

2. For Internal Use Only – Not For External Distribution © 2015 CRISIL Ltd. All rights reserved. 2 Agenda  Retirement funds – An Overview  Provident funds turn to equity  Opportunities – pushing ‘young’ India into long-term investing  Challenges

3. For Internal Use Only – Not For External Distribution © 2015 CRISIL Ltd. All rights reserved. 3 Retirement Funds – An Overview (1/2)  In the private sector, insurance and mutual funds also provide retirement products but they have met with limited success  India’s joint family system has historically been the unsaid pension system for the elderly –With the advent of nuclear families, a pension coverage plan is imperative for the nation’s elderly 1948 Coal Mines PF 1952 EPFO 1955 Assam Tea Plantations PF 1966 Seamen’s PF Scheme 1995 EPS 2004 NPS 2009 NPS opened to public 2010 Swavalam bhan scheme launched 2015 Atal Pension Yojana Varishtha Pension Bima Yojana introduced by the NDA government in 2003-04, has been revived for the period from August 15, 2014 to August 14, 2015.

4. For Internal Use Only – Not For External Distribution © 2015 CRISIL Ltd. All rights reserved. 4 Retirement Funds – An Overview (2/2)  The Indian retirement fund industry has had a bias toward investments in fixed income securities  This bias has meant that returns are limited, and often inadequate to see one through the sunset years  For the social security net to be more effective, this needs to change - and soon Retirement industry EPFO (including exempted trusts) Investment in fixed income instruments Asset size – Rs 7.39 lakh cr* Other PFs ~ Investment in fixed income instruments Asset size - Rs 0.65 lakh cr Public Provident Fund (PPF) Investment in fixed income instruments Asset size – Rs 0.46 lakh cr* National Pension System (NPS) Investment across equity and debt Asset size – Rs 0.88 lakh cr^ Life insurance plans Investment across equity and debt Asset size – Rs 3.38 lakh cr* Mutual fund pension plans Investment across equity and debt Asset size – Rs 0.02 lakh cr $ ~ Includes Assam Tea Plantations’ provident fund, pension fund schemes & DLI schemes; Coal Mines’ PF and Seamen PF (data as per latest available) ; * March 2014 ^March 2015 $June2015

5. For Internal Use Only – Not For External Distribution © 2015 CRISIL Ltd. All rights reserved. 5 Provident funds turn to equity  Ministry of Labour & Employment has allowed investments in equity between 5% and 15% of incremental annual inflows  Benefits of investing in equity over 30 years* –Even a small exposure (5%) to equity adds Rs 9 lakh to the vested amount –15% exposure (still a minority share) results in additional Rs 28 lakh  Globally, too, equity is a preferred investment class for pension money –As per OECD, large pension funds had, on average, 31.5% equity exposure Rs Lakh Exposure to equity 0%5%10%15% Amount contributed 30 Vesting amount 149158167177 * Debt returns assumed at 9% CAGR, an approximate to the current declared EPFO rate of 8.75% Equity returns assumed at 15% CAGR which is the average of daily annualised rolling returns over 20 years of S&P BSE Sensex since its inception in 1979

6. For Internal Use Only – Not For External Distribution © 2015 CRISIL Ltd. All rights reserved. 6 Opportunity – pushing ‘young’ India into long-term investing  Reaping the demographic dividend through asset allocation –India is a young country with most of its population less than 30 years old… –…but the asset allocation profile resembles a person nearing retirement -- debt-oriented –Exposing PF to equities would help align the long-term horizon of the retirement corpus with the asset class  Opportunity to transcend market cycles –The equity market is cyclical – volatile in the short term but has historically generated high returns in the long term Source: BSE

7. For Internal Use Only – Not For External Distribution © 2015 CRISIL Ltd. All rights reserved. 7 Challenges  Shift from the declared rate regime –PF money, until now, was being managed in the held-to-maturity (HTM) format –This allowed PFs to declare an interest rate based on the accrual interest in the underlying portfolio –With equity in the picture, declaration of interest rate on an annual basis would be a challenge  Limited equity exposure –The equity share proposed for PFs would have a minimal impact on the product’s asset allocation and overall returns –With the current exposure and mark-to-market (MTM) gains of 15%, the portfolio’s equity exposure would cross 5% in the 13 th year  Deleveraging risks –At least 5% of investor inflows into PF money will be in equity, even at the time of retirement –So, the risk of the asset class will not be deleveraged near retirement  While the challenges are operational, the benefits outweigh and are a good start for the industry

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9. For Internal Use Only – Not For External Distribution © 2015 CRISIL Ltd. All rights reserved. 9 Global asset allocation of pension funds Asset allocation (%) - select OECD countries* CountrySharesBills and bondsCash and depositsOthers^ United States49.520.80.928.9 Australia49.18.417.724.8 Canada31.734.63.530.1 United Kingdom24.130.73.341.9 Mexico23.675.10.90.3 Japan11.237.15.546.1 Asset allocation (%) - select non-OECD countries* Country SharesBills and bondsCash and depositsOthers^ Hong Kong, China 60.522.712.94.0 Colombia 31.552.62.813.0 Brazil 27.953.20.118.8 South Africa 23.09.55.861.7 Indonesia 17.449.725.57.4 Thailand 14.257.227.80.7 *Source: OECD Global Pension Statistics ^ Category includes loans, land and buildings, unallocated insurance contracts, hedge funds, private equity funds, structured products, other mutual funds (i.e. not invested in cash, bills and bonds, or shares) and other investments

10. For Internal Use Only – Not For External Distribution © 2015 CRISIL Ltd. All rights reserved. 10 Fiscal cost of ageing: Scenario-1 (Best case) 10 Vibrant private pension + targeted pension scheme from government 201520302050 Number of needy old covered (30% of total), (in million)-5489 Pension expenses to cover the needy old, (at Rs 2000 per month per person in today’s prices), (in Rs trillion) -777 Pension expenses to cover the needy old, (% of GDP)-1.11.9 Pension and retirement benefits to government employees, (% of GDP) 2.2 0.7 Total fiscal burden, (% of GDP)2.23.42.6 Private sector coverage expands: 70% retirees get pension compared with just 8% now Government provides pension support to 30% of the old who are needy, in addition to government retirees. Today, the government provides pension to only 19% of the old under Indira Gandhi National Old Age Pension Scheme. On average, these pensioners get Rs 500 per month. –Targeted pension scheme proposed here envisages a payment of Rs 2,000 per month. Source: United Nations Population Division, 6 th Pay Commission Report, Ministry of Finance for payment of pension and retirement benefits, Ministry of Rural Development for estimates on payment under Indira Gandhi National Old Age Pension Scheme, World Bank data on defence employment, Estimates made by Bhardwaj and Dave (2006), CRISIL Research

11. For Internal Use Only – Not For External Distribution © 2015 CRISIL Ltd. All rights reserved. 11 Fiscal cost of ageing: Scenario-2 (Worst case) 11 Private-sector pension coverage stays chronically low at its current level Government formulates a pension scheme to support the entire old-age population which raises pension bill to 4.1% of GDP by 2030 If the government is to give pension matching the best-case scenario (Rs 2,000 per person instead to Rs 1,000), its fiscal burden will surge to 6% of GDP by 2030 Private pension schemes do not take off and government provides pensions to all 201520302050 Number of old, (in million)112181297 Pension expenses on universal pension scheme (at Rs 1,000 per month per person in today’s prices), (in Rs trillion) -12128 Pension expenses on universal pension scheme, (% of GDP)-1.93.1 Pension and retirement benefits to government employees, (% of GDP) 2.2 0.7 Total fiscal burden, (% of GDP)2.24.13.9 Source: United Nations Population Division, 6 th Pay Commission Report, Ministry of Finance for payment of pension and retirement benefits, Ministry of Rural Development for estimates on payment under Indira Gandhi National Old Age Pension Scheme, World Bank data on defence employment, Estimates made by Bhardwaj and Dave (2006), CRISIL Research

12. For Internal Use Only – Not For External Distribution © 2015 CRISIL Ltd. All rights reserved. 12 Real returns on the decline 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 1990199419982002200620102014 Retail inflation ratePF return  Yield on India’s 10-year benchmark has fallen from near 14% in 1995 to under 8% currently