• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

The newly introduced senior citizens savings scheme is a poor substitute for Varishta Bima Yojana. The scheme also favours senior citizens with higher surpluses. Innovative ways involving equity market investing could have been explored.

THE Finance Minister's subsidy shearing scalpel has also zoomed in on the savings scheme for senior citizens. The Varishta Bima Yojana, a bonanza for low income earning pensioners with lower amount of surplus, has been replaced with a savings scheme that will benefit pensioners with a higher amount of surplus in their hands.

The Finance Ministry, which has thought of a defined contribution pension scheme for central government employees, could have explored innovative ways to deliver higher returns for senior citizens that would also entail a lower subsidy.

Cut to size: The Varishta Bima Yojana was a 15-year scheme. The maximum investment was Rs 2.66 lakh. Its replacement is only a five-year scheme. The maximum investment possible is Rs 15 lakh. Both promise 9 per cent. Income from Varishta Bima was tax-exempt. Income from the new savings scheme is taxable.

The taxable nature of the new scheme is strictly not a deterrent for a senior citizen with a lower surplus. Given that incomes up to Rs 1.5 lakh will not suffer tax for a senior citizen, that would not be a worry. But that the scheme is only for five years is of consequence. He may have to deal with interest rate volatility after five years. Varishta Bima offered valuable protection up to 15 years.

The scheme will be attractive only to a senior citizen with surpluses in excess of Rs 6 lakh. This is because the post-office monthly income, whether combined with post-office recurring deposit or not, would offer higher returns than the new scheme.

To the senior citizen, the new scheme would only serve as a substitute for the 6.5 per cent tax-free RBI Bonds, which has been withdrawn. The new scheme offers an after-tax yield of six per cent. Effectively, the earmarked subsidy will not flow to senior citizens with surpluses of less than Rs 6 lakh.

Innovation possible: The cornerstone of the defined contribution pension scheme is its reliance on the equity market. The equity market delivers higher returns than debt markets and helps to beat inflation. In addition, investing in the equity market need not even increase risk.

On the contrary, for a long-term portfolio, zero exposure to equities is riskier than exposure of about 15-20 per cent. The Finance Ministry, therefore, could have relied on the equity market to deliver higher returns to senior citizens too.Such a scheme could have the following features:

* In the beginning, 20 per cent of the corpus could be invested in equities. For instance, if Rs 100 were invested in total, Rs 20 would be invested in equities.

* If the equity portfolio is above Rs 20, profits will be booked and the surplus would be taken out of the debt portfolio

* If the equity portfolio is less than Rs 20, the Government will make good the losses (the subsidy portion) and the portfolio will get restated to Rs 20

* In addition, surplus from the equity market and the income from the debt market would be used to pay the annual income to the subscribers.

* If such a payment reduces the portfolio to less than Rs 100, the Government will infuse cash (the subsidy portion) to restate the value to Rs 100.

* In effect, in the next 15 years, the amount invested in equity at the beginning of a year will stay constant, at Rs 20. The amount invested in the debt market would stay at Rs 80 or rise depending on the performance of the equity market.

Given that equity market performs exceptionally better than the debt market during a 15-year term, it is highly likely that the subsidies will come down sharply. At the same time, senior citizens would have been provided with a guaranteed income.

Favourable past: Would such a scheme have worked well in the past? Consider a 10-year scheme. Let us assume that the equity portfolio returns mirror that of BSE 200, debt investments earn 6 per cent each year and interest payment of 9 per cent is made each year.

Let us consider the period from the beginning of 1991. Since 1991, four rolling ten-year periods have ended. That is from 1991-2001 to 1994-2004. For a Rs 100 portfolio, the cumulative subsidy payment for three of the four periods was lower than Rs 27, which would have been paid if no money had been invested in the equity market.

If the present value of the subsidy payments is considered, which is the correct approach, the value of subsidy for all the four periods is lower.

The simulation can be considered as extremely positive. This is because market performance over 15 years is much better compared to ten-year periods. In addition, active management, such as through equity mutual funds, can deliver higher returns than BSE 200. Hopefully, such innovative ways to deliver value to senior citizens will be adopted in the years to come.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Investment Quiz

Copyright © 2004, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line