Trustees of private exempt provident funds are advising their members to withdraw money from their provident fund accounts.

They say employees will be better off utilising the money now rather than letting it stagnate in their provident fund accounts. As a result, loan withdrawals from employees' provident fund accounts trebled in 2002-03.

The proportion of loan withdrawals increased from 10-20 per cent of the total corpus in 2001-02 to about 60 per cent in 2002-03.

If provident fund trustees are encouraging their members to take non-refundable loans against past contributions, it is because of the increasing difficulty in making investments that will bring in the 9 per cent government-stipulated rate of interest.

Investment in high yielding corporate or state government-guaranteed paper carries the risk of default and, consequently, the possibility of capital erosion.

Amit Gopal, assistant vice-president of India Life Asset Management Company said: "Today, 60 per cent of the incremental contributions are going into employee loans. This is a distressing trend that is seeping into large engineering and software companies."

Under 3,000 exempt provident funds in the country manage well over Rs 130,000 crore (Rs 1,300 billion).

Today, a 10-year central government paper is ruling at 5.76 per cent. A triple-A (AAA) long-dated corporate paper fetches no more than 6-6.5 per cent. Papers guaranteed by state governments offer over 10 per cent, but are known to default in payment of interest and principal.

Provident fund trustees are finding it more productive to give employees loans out of their own funds. Consequently, provident fund contributors have started treating provident fund accounts like bank accounts.

A contributor is eligible to take a loan against his provident fund account after contributing to it for five years. If the loan is to be refunded, the interest cost is 1 per cent higher than the interest paid on the provident fund. For non-refundable loans, there is no interest cost.

Essentially, non-refundable loans eat into the provident fund corpus and, therefore, the trustees are spared the trouble of finding avenues for investing the corpus.

This practice is rampant in factories with huge work forces. It is also spreading to Indian and multinational software firms, not because these employees need loans, but because trustees are pushing the concept.

While employees of exempt funds are now allowed to take refundable or non-refundable loans on certain grounds after five years, this practice was discouraged in the past.