Pension Reforms Reversal?
India can ill afford a reversion to the old pension system; instead the NPS has to be made more attractive for employees. — KK Srivastava
In a recent RBI study it is estimated that if the old pension scheme (OPS) is brought back throughout India, the cumulative fiscal burden on the governments would be 4.5 times the outgo towards the existing National Pension System (NPS), thereby severely compromising the government finances which mostly remain in precarious state. It may be noted that in recent times five states - Rajasthan, Chhattisgarh, Jharkhand, Punjab and Himachal Pradesh. (Incidentally none of them is BJP ruled) – announced their decisions to revert to OPS for government staff. Maharashtra has indicated a reexamination of the old scheme.
This reversal to OPS has prompted the centre to set up a committee to look into the ways of making the NPS attractive enough and yet not saddle the exchequer with an unfunded liability. Short term reduction in states’ pension outgo (since there will be no NPS payments done every month) perhaps could be the immediate provocation for going back to OPS; but such reversion to OPS by governments would be fiscally unsustainable.Worldwide most countries are moving from defined benefit’ to ‘defined contribution’ plans. Reverting to OPS then will compromise the interest of future generations. By 2050, pension outgo under OPS is projected to touch over Rs. 17 lakh crore as against Rs. 4 lakh crore under NPS. The burden under OPS by 2060 would be nearly 1% of GDP.Infact, states pension expenditure account for around 38% of their committed expenditure.
In a large and diverse country like India, especially with limited social security measures, the government finds it difficult to push economic reforms which invariably have a short term cost but long term benefits. Pension reforms is one such.Due to improved standards of living and availability of quality medical for a larger time, and therefore a pressure on precarious government finances. More the government has to commit its funds for this item of revenue expenditure, less shall be available for investment in building capital assets like social and economic infrastructure (roads, schools, hospitals …).
Not only that many countries are moving away from defined benefits arrangements to defined contribution pension plans, they are taking other steps to reduce the fiscal burden entailed under the former. These include reducing pension benefits, increasing retirement age, and raising contribution rates to reduce the burden on the exchequer. In India, the expenditure on pension has increased from 0.6% of GDP during 1990s to nearly treble at 1.7% of GDP in 2022-23. This leads on one hand to slipping on fiscal balance and on the other skimping on projects essential for growth and development.
As said above defined pension is paid from the current revenue of the government. Notably, the pace of increase in pension liabilities is more brisk than the revenue growth. This obviously cannot be sustained in the long run. That is exactly why countries like US, UK, Australia, Swedan and Japan have been putting more onus on the beneficiary to provide for his own retirement safety net. It may be noted that this also gives the retiree more control over his post retirement assets. However, it is also true that in OPS the individual bears no investment risk (as he does under NPS), is not exposed to market fluctuations. Moreover, he is entitled to a stable income – thereby enjoying financial stability – in his sunset years. But, on the flip side, such gains are coming to only the OPS beneficiaries, and at the expense of resources being moved from the overall growth and development in the economy. The RBI study says that the yearly contribution of states to the retirement corpus under the NPS is likely to increase from 0.1% of GDP to 0.2% by 2039. But it will start declining after that. On the other hand if the states opt for OPS-and drop NPS – the immediate contribution will drop to zero, but in future the outgo on pension account will prove more expensive.
There is also the argument that electoral politics is forcing the hands of the state governments since employees (read voters) prefer defined benefits (which are assured, and contrasted with NPS, at least presently are higher under OPS). There is thus the real risk that more state governments may revert to OPS under political and electoral pressure. Normatively, the states should resist opting for short term fiscal and political gains, for all such gains are likely to be eclipsed by long term costs. Thus, according to the above quoted RBI study, if all states embrace OPS, then the additional outgo would be on a par with what it would have been under the NPS by as early as mid - 2030s, and eventually exceed it by 2040. But thereafter, the additional burden will increase rapidly, reaching around 0.9% of GDP annually by the early 2060s, as we had said earlier too.
Though government employees are just over 5% of Indian workforce - and their share is shrinking - they wield disproportionate influence due to the fact that they are organisedand because they are very close to decision making. No political dispensation would like to put them in ill humour or would dare lose their confidence. So what can be done?
Well, due to strident criticism - and increasing demand for restoration of OPS - from the post 2004 government appointed employees the government appointed committee is now exploring ways to bring NPS benefits as close to OPS. This is partly due to electoral considerations (Himachal defeat of BJP) and partly because the private sector is now on the uptake as regards NPS. Is a hybrid scheme - combination of defined benefits and defined contribution - in the offing? Well, we will h ave to wait for a definitive response.
The government also needs to educate the general electorate that it is not that only OPS is pro worker. Definitely it is pro-pension beneficiaries, but overall it may not be pro-people, particularly for informal sector which does not enjoy any such benefits, but is deprived of funds that could have been spared - sans the new OPS burden - for overall economic growth; the latter ofcourse benefits the society at large and not merely only a privileged section. Over 80% of India’s workforce is in informal sector; it does not enjoy any employment benefits, leave alone old-age income security.
OPS cost - actual and potential (that is if OPS is reintroduced all around) - is indeed huge for the state. Notwithstanding the short to medium term possibility of erosion of value of assets supporting the contribution based retirement system, it is not to deny or negate the long term economic rationale for funded, market linked pension systems. Pension reforms cannot be undone; what is needed is to evolve a more acceptable system that takes adequate care of retirees in future.
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