Central Provident Fund in Singapore a Capital Market Boost Or a Drag?

Central Provident Fund in Singapore A Capital Market Boost or a Drag? Edward Ng Edward Ng is Senior Lecturer at the Department of Finance and Accounting, National University of Singapore 56 A STUDY OF FINANCIAL MARKETS A Brief History ○○○○○○○○○ three years after Singapore became independent from the Malaysian Federation, when CPF savings The Central Provident Fund (CPF) scheme was in- were allowed to be withdrawn for the first time but troduced as the national funded pension scheme on limited to the purchase of government flats. This 1 July 1955 under the British colonial government. was the first policy measure wherein the govern- ○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○ Although it was evidently a pension fund for retirement used CPF savings to achieve national objec- ment, it was not meant to be the single social security tives. This period of the nation’s history was system that it is today. Just before Singapore achieved marked by political and social turmoil. Singapore self-government in 1959, a plan was in place to intro- did not become independent by choice and was duce a social insurance cum public assistance scheme largely considered economically unviable. Popu- to cater to the needy. At first, the scheme covered all lated largely by immigrants, it faced the risk of an employees in Singapore except those working in the exodus, which would have made the country’s col- civil service or contributing to other approved provi- lapse a self-fulfilling prophecy. The government 1 dent funds. This plan was later scrapped, however, thus decided that home ownership was the way to as the first local government in 1959 believed it would make its citizens cast their lot with the new nation. take “available capital resource from other even more With little surplus and private savings, the funds 2 pressing needs.” While the CPF scheme has re- in the CPF accounts were identified as a source of mained as Singapore’s national funded pension valuable financing. Figure 1 shows how CPF sav- scheme over the past four decades, its character has ings have been used to fund the development of substantially changed. It retains its primary role as a government housing projects. pension fund for retirement, but its functions have Figure 1: Circular Flow of Central Provident Fund been expanded to include funding medical expenses Savings to Finance the Construction of as well as property and financial investments. Today, HDB Flats Monthly contribution from employer the CPF Board (Central Provident Fund Board is the Buys SGS official name) is more like a mandatory savings bank, Government CPF Board a significant portion of whose assets can be channeled Deduction Individual from monthly to “desirable” activities like home ownership. salary The evolution of the CPF scheme was not acciden- Buys flat HDB Flat Extends mortgage tal. The scheme came about through a calibrated series Finances loans construction for flat of measures designed to exploit a critical pool of funds Housing and Allocates for Development Pays mortgage in a small developing country. However, one overrid- building Board installment from HDB flats monthly contributions ing principle that has not changed over the years is CPF = Central Provident Fund, HDB = Housing and Development Board, individual responsibility for one’s own future. The SGS = Singapore government securities. emphasis on individual decision making and responsibility has always been the central tenet in the manage- By most measures, the policy was a great suc- ment of CPF savings and had a significant influence in cess. Today, about 80 percent of Singapore citizens the development of the securities markets in Singapore. and permanent residents live in government flats. The flats have also become a valuable investment Central Provident Fund as a as most of them command market values more than Financing Tool double their purchase price. There are two landmark events in the development The second major policy change occurred in of the CPF scheme. The first took place in 1968, 1986. That year the government decided to pull the CENTRAL PROVIDENT FUND IN SINGAPORE: A CAPITAL MARKET BOOST OR A DRAG? 57 economy out of its most serious recession since ○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○ Changes in the Central independence. “Sunrise” industries were identified but the securities markets had to be tapped for the Provident Fund Scheme new businesses. Thus, individuals were allowed to In its early years, the CPF scheme was largely invest CPF savings in risky financial assets. This devoted to savings for retirement. The static contri- was not, however, the first time CPF savings could bution rate of 5 percent each by the employer and be invested in the securities market. Early in 1978, the employee on the salary and the undivided indi- CPF members were allowed to invest their savings vidual CPF account quite clearly reflects this objec- in shares of the Singapore Bus Service Ltd. (SBS). tive. If this contribution rate had remained, an indi- SBS shares were, however, not a really risky in- vidual would have consistently set aside 10 percent vestment as the firm was a government-linked of his salary for retirement. monopoly that generated healthy cash flows. Each Not long after the country’s independence, the member was also limited to the purchase of S$5,000 government implemented rapid changes. First, the worth of shares. The 1986 measure was intrinsi- contribution rate was increased almost every year. cally different in terms of the risk profile of the With just three increases starting in 1968, the con- investments allowed. An Approved Investment tribution rate reached 10 percent by 1971, which was Scheme was initiated and has so far been regularly double the original rate. By 1974, the CPF contribu- updated. The original list of approved assets in- tion was 30 percent of a member’s salary. Such a cluded selected blue chip stocks, unit trusts, and high savings rate is evidence of the intent to make gold. CPF more than a pension scheme for retirement. One important aspect has remained unchanged The second change was the departure from the despite the measures to liberalize the use of CPF equal burden on the employee and the employer. The savings. The principal amount plus the accrued contribution rate first became asymmetric in 1972. interest cannot be withdrawn until the member While the employee’s contribution remained at 10 reaches the age of 55. Rather than using his own percent as in the previous year, the employer was money, the CPF member is “borrowing” from his made to contribute 14 percent. This marked the be- savings. Anytime an investment, whether property ginning of the fine-tuning of the CPF scheme to or securities, is liquidated, the CPF Board has the achieve various social and economic objectives. first claim to the principal amount used and any The third change took place in 1977 when the interest that has accrued over the holding period of individual’s CPF account was divided into two the investment. Only after these amounts have been subaccounts. The Special Account was created to returned to the individual’s CPF account can any ○○○○○○○○○○○○○○○○○○○○○ ensure that a minimum level of financial needs could capital gain be permanently withdrawn. A capital be met at retirement. Funds in this account cannot loss, however, does not need to be reimbursed by be withdrawn except at retirement. Starting at 1 per- the individual. cent of salary, the contribution rate for the Special The CPF scheme is quite clearly not a conven- Account quickly rose to 7 percent in 1979. tional pension system. Carefully timed measures The major portion of the CPF savings goes into have been introduced to allow this increasingly large the Ordinary Account. Since the Special Account is amount of forced savings to be productively em- truly the pension savings, the Ordinary Account is ployed to finance the nation’s development. Appen- aimed at other possible uses. Beyond the regula- dix 1 gives a chronology of these measures. tory minimum percentage for the Special Account, 58 A STUDY OF FINANCIAL MARKETS ○○○○○○○○○ an individual has the option to transfer funds from Figure 2: Approved Uses of Central Provident the Ordinary to the Special Account. A transfer in Fund Savings for Every S$40 of a the opposite direction is, however, not allowed even Member’s Balance if it is to reverse from the Ordinary Account. On the other hand, the Special Account enjoys a slightly S$4 ○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○○ higher interest rate than the Ordinary Account. S$6a In 1984, the CPF account was further divided. Besides the Ordinary and Special Accounts, a third S$30 account called the Medisave Account was created. Funds in this account were specifically targeted at medical expenses, initially for the account holder Ordinary Account (housing, approved investment, CPF insurance, himself and later expanded to cover immediate fam- tertiary education, topping up of parents’ retirement accounts) Medisave Account (hospitalization expenses, hepatitis-B vaccinations, approved outpatient treatments, approved ily members. medical insurance premium) Right from the country’s independence, the gov- Special Account (for old age and contingencies) ernment has intended the CPF scheme to be a cen- a Members above 35 but less than 45 years old are required to contribute S$7 for every S$40 in their CPF balance to the Medisave Account and S$29 to the Ordinary Account. Those above 45 years old tral social and economic policy tool while preserv- need to contribute S$8 to a Medisave Account and S$28 to the ing the savings-for-retirement purpose as much as Ordinary Account. 3 possible. The present CPF scheme is far more than just a pension system. It serves three broad objec- scheme for its economic policies. Beginning 1 Au- tives. The first is to preserve and enhance the gust 1995, all employers were exempted from hav- individual’s integrity.

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