The Hindu Business Line : Exit options for an aging population

It is necessary, and extremely important, to allow employees to exit whenever they choose to do so from the pension plan, as also from the Employees Provident Fund and the Public Provident Fund, the rates of return on which have been unilaterally slashed by 20 per cent or more.

HALF of India's population in 1981 was less than 20 years old. Though age-wise tabulations for 2001 are not yet in public domain, this proportion may well have risen. Whether or not this is indeed the case, India is today certainly a great deal younger than it was half a century ago. At the same time, paradoxically, it is people above 60 (numbering about 43 million in 1981) who constitute the fastest growing segment of the population; with the exception of people over 70, and the 80-plus! The reason for this is simply that people now live longer; life expectancy has increased dramatically. The result is that an ever-larger portion of the working population survives the age of retirement; ever-larger numbers are still alive 10-15 years after they have retired.

This increases the importance of the question of how these people, after they have retired, are to keep body and soul together. Of course, there is no retirement age for the overwhelming majority of India's population; less than 30 million people had jobs in the organised sector in 2001. The others simply have to keep on working until they drop — or are dropped by families no longer able and/or willing to support them.

Things are of course very much better for those who graduate out of (or `voluntarily retire' from) organised sector employment. These people are better able to provide for their future whilst they are still employed. And at least in the case of the public sector (which accounts for 70 per cent of organised sector employment), pensioners could, until the introduction of the present pension reforms, confidently expect to maintain a reasonable standard of living for as long they lived.

The Pay Commissions not only gave them a degree of protection against the erosion of their pensions on account of inflation, but also substantially increased the pensions payable to them. Today, pensioners who retired in, say, 1980, no longer have to struggle to make ends meet on the basis of the pensions that they were entitled to at the time they retired; which, of course, were computed on the basis of the far lower salaries that were then the norm.

Their pensions have since been dramatically increased in order to do away, at least partially, with the way they were unfairly handicapped (vis-a-vis those who now retire at comparable levels of seniority), by the enormous salary hike that was brought about as a result of the recommendations of the Fourth Pay Commission.

This, coupled with increased life expectancy, has today got the public sector trapped in a situation where budgetary provisions that have to be made for the payment of pensions have greatly added to the difficulties of coping with the near-crippling increase in the wage bill. Pensions already exceed wage payments in a number of cases, and this problem is expected to increase over time as a result of efforts to downsize the workforce in the public sector; and curb its future growth. A similar downsizing of pensioners is, of course, not an available option; and for most governments downsizing pensions instead is not in the realm of practical politics.

To find a way around this problem, the Finance Minister, Mr Jaswant Singh, has devised a `forward-looking' policy under which pension payments, instead of being charged to future budgets in toto, are expected to get funded largely `of their own accord'. All Central Government employees who joined service after October 2002, excluding the Defence personnel, would be covered under a contributory pension scheme. Under this scheme, employees would be required to set aside 10 per cent of their salary and dearness allowance. The government would match this contribution, and also provide tax preferences up to a certain limit. Employees would have three options of investing the money thus earmarked for pension payments. One, 60 per cent of the investments would be made (by "pension fund managers") in government securities, 30 per cent in "investment grade corporate bonds" and 10 per cent in the equity market.

Another option is that investments would be "around" 40 per cent each in government securities and investment grade corporate bonds, and the remaining 20 per cent in equities. Three, employees can choose to invest 25 per cent each in government securities and investment grade corporate bonds, while 50 per cent of the funds are invested in the equity market. "Pension fund managers would be free to make investments in international markets, subject to regulatory restrictions and supervisory provisions". Finally, an independent Pension Fund Regulatory and Development Authority (PFRDA) would be set up for overseeing the "pension sector".

The Finance Ministry announced in August that it has decided to "kick-start the pension reforms and set up the Pension Regulatory Authority and central record-keeping agency by the end of this year. Two months later this was followed up by an announcement that a five-member PFRDA had been constituted and would "come up with guidelines for the new pension system expected to become operational from January 1, 2004".

The worrying aspect of the proposal is that the Finance Ministry's track-record of cutting interest rates — on `small savings', on money held in trust for employees by the Employees Provident Fund, and on the Public Provident Fund — is part and parcel of a larger plan to stimulate the growth of the stock market by any and all means available, including generous tax incentives on capital gains; the use of persuasion or force to get pension, insurance and bank funds to `play' the market; encouraging the flow of foreign portfolio investments; and last, but not least, unleashing and/or endorsing a great deal of hype about the bright future that is in store for equity investors, in terms of capital gains rather than dividends which, in any case, based as they are on the face value of stocks, rather than their market value, are inherently incapable of making much of a contribution.

Prospects of large capital gains, however, tempting and imminent as they can be made to seem, are slippery. There are instances in recent memory where the level of the Sensex at two points of time, ten or fifteen years apart, has been about the same; implying an actual drop in real worth. The easy repatriability or convertibility of foreign capital inflows hardly helps; despite the relatively stable position over the past decade or so, the fact is that foreign capital flows are inherently volatile in nature; and are likely to become more so in the years to come given the recent developments in the exchange rate policy of the US.

Another complication is that while a rapidly rising stock market is fundamentally dependent on expectations, the government, despite its many substantive, and substantial, actions on the `demand side', has so far not been able to make much of an impact on the `mood' of the market. Every time it shows signs of racing towards a take-off, `profit taking' brings prices down again — at which time, quite predictably, `market managers' vigorously woo small investors with the thought that prices having fallen as they have, now is the time to buy.

What happens in the long term is anyone's guess; but two things are certain. First, the Government's package of measures is likely to force or tempt employees to prefer the more risky investment options. Second, unlike professionals or institutions `playing' the market, pensioners do not have the option of cashing in when the going is good.

According to the plan the Finance Ministry is now putting into effect, employees would "normally exit from the scheme at the age of 60", after which they would be required to use 40 per cent of the accumulated wealth to buy themselves an annuity. This second part of it is all very well; inasmuch as it introduces an element of certainty and shelters employees from any further market risk so far as `bare subsistence' is concerned. But the basic problem is that employees have absolutely no control over what stock prices will be, and cannot guess where they will stand, at the time of their exit; which, unlike professionals and institutions, they cannot do at a time of their own choosing.

The conclusion that all this points to is that it is necessary, and extremely important, to allow employees to exit whenever they choose to do so. From the pension plan, certainly; but also from the Employees Provident Fund and the Public Provident Fund, the rates of return on which have been unilaterally slashed by 20 per cent or more.

Many investors could well decide that investments in tangibles such as land, housing, or gold, are safer — and more profitable — than savings in financial instruments. And those who choose to stay in, even after the doors are thrown open, will have the satisfaction of knowing that there is an available way out; that they are not locked in; that they do not have to face the future with their hands tied behind their back.

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