Those opposing changes to pension norms should realise there's no escaping a role for markets to expand coverage.
As with most other issues, the debate on pension reforms in India misses the wood for the trees.
Last week, the government caved in to opposition from its allies and deferred the seven-year old PFRDA (Pension Fund Regulatory and Development Authority) Bill.
The issues raised are not exactly new and are actually peripheral to the core problem with India's pension system. For one, there is strenuous objection to having a pension system that is based on defined contributions, rather than defined benefits. Even as the Bill suggests a pension system that delivers market-linked returns on contributions made by employees, its detractors are asking for ‘assured' returns.
Two, there are protests that the new system is too strict, especially in barring employees from making premature withdrawals from their retirement corpus.
Finally, there is vague fear about allowing foreigners and private companies to manage the savings of the salaried. Entangled in this, is the issue of whether pension funds can have 26 per cent FDI (Foreign Direct Investment).
But why these objections must make the government go weak-kneed is hard to understand. These issues were first raised twelve years ago and have been discussed threadbare by several expert groups since.
The real problem with India's pension system was flagged by the Old Age Social and Income Security (OASIS) report way back in 2000. Its conclusions were subsequently refined by the International Monetary Fund and many other committees. These studies highlight that the Indian pension system as it stands today suffers from huge inadequacies. To cut a long story short, these are the issues:
Growing ranks of elderly: The ranks of the elderly in India are growing at a higher rate (3.8 per cent per annum) than overall population (1.8 per cent). By 2030, therefore, the number of people over age 60 is expected to soar from the current 80 million to nearly 200 million. This will sharply increase the number of people per family depending on the working member for sustenance. The current pension system in no way provides for this shift.
Poor coverage: Only a small portion of India's working population is covered by any form of old age security even today. One estimate says that of the 420 million workers in India, nearly 307 million are in the unorganised sector with no formal pension. Formal pension systems cover only about 12 per cent of the workforce.
This clearly suggests that unless pension coverage is increased, a majority of the current workforce may find itself impoverished and unable to support itself post-retirement. Rising longevity would also increase the risk of this population outliving retirement savings.
Where's the money?
Despite what one may demand, the government is in no position to provide pensions for India's burgeoning ranks of the elderly. In fact, even funding for the pension schemes that it now oversees is in some doubt. The pension schemes that come directly or indirectly under the government's ambit today are the Civil Servants Pension scheme (for government employees recruited up to 2003), Employees Pension Scheme, Employee's Provident Fund and the Special Pension Scheme (the last three are available to private sector employees).
All of these schemes are defined benefit schemes. That is, in return for the employee contributing a portion of his salary to the scheme, they offer a fixed annual return. These schemes, managed by quasi-government organisations, are subject to onerous investment restrictions.
The problem with these schemes is that they often do not generate sufficient returns to deliver to reasonable return expectations, leave alone consistently beating inflation.
What is even more alarming is that these schemes are now run on a pay-as-you-go basis. That is, contributions of new employees go into funding pension payouts for the retired. The lack of any official estimates on how much these pension payouts will cost the exchequer over the long term, or how it plans to meet them, raises questions on whether government-guaranteed pensions are sustainable at all.
It is these issues that the PFRDA Bill seeks to address. With effect from January 2004, newly recruited government employees were migrated to the New Pension Scheme (NPS).
The NPS mandate is clear. It is to operate on defined contributions and not benefits. Initially meant for government employees, it is eventually to be extended to the private sector and self-employed and informal workers too.
Investors in NPS reap returns based on the success of the scheme's investment performance. Though NPS may invest in equities too to lift returns, it does offer a varied menu of options to employees who want to opt for low or nil equity in their retirement portfolio.
The NPS is designed to have fund managers from both the public and private sectors, selected on the basis of competitive bidding. They will disclose their performance at annual intervals and investors will enjoy flexibility to shift between schemes and managers, based on this. The pension regulator PFRDA is to oversee the NPS and set the terms and conditions for it. Though flagged off in 2004, the Bill to vest the PFRDA with the requisite powers and the NPS with regulatory sanction has been hanging fire until now.
All this makes it clear why the recent objections to the pension Bill stand on shaky ground.
Overhauling the pension system is essential because India's pension schemes are not delivering the expected benefits in the first place.
The new system promises transparent selection of managers, planned asset allocation and regular disclosures. These may help investors see exactly where their pension contributions are going. Given the flexibility to switch between managers, competition may deliver good performance too. After all, in a pension fund, beating inflation through a healthy return is much more important than state guarantees.
Yes, it would be good if pensions did not depend on the markets. But with the government is in no position to fund such a system, that is a utopian aspiration. Given that much of India's workforce today gets no pension benefits at all, something would surely be better than nothing.