The pension system in India has indeed evolved from primarily being based on defined benefits (DB) to incorporating elements of defined contributions (DC). This transition is particularly evident with the introduction of the National Pension System (NPS) in 2004, which shifted from a defined benefit structure to a defined contribution system.
Under the NPS, both employees and employers make regular contributions to individual pension accounts. Retirement benefits depend on the accumulated contributions and investment returns. The Reserve Bank of India’s latest report (September, 2023) opines that reverting to the old pension scheme by States may lead to significant long-term fiscal burdens, despite short-term savings.
Global Pension Trends
Globally, countries like the US, UK, Australia, Sweden, and Japan had transitioned from defined benefits to defined contribution pension schemes. This shift, which is more fiscally sustainable, placed more onus on individuals to provide for their retirement.
Increased life expectancy, the need to limit budget deficits, and the desire to give people more control over their retirement assets are the reasons why defined contributuion plans are gaining momentum.
In spite of global trends, Rajasthan, Chhattisgarh, Jharkhand, Punjab, and Himachal Pradesh, have recently announced their plans to revert to the Old Pension Scheme (OPS). Vote bank politics is often the reason why some States are reverting to OPS.
Moreover, OPS eliminates the investment risk borne by individuals in NPS, ensuring that retirees are not exposed to market fluctuations, and also contributes to economic stability by providing retirees with a stable income, reducing the risk of sudden income drops and financial instability among the elderly.
The primary argument supporting the return to OPS often revolves around the immediate fiscal relief it promises. OPS is seen as a way to quickly reduce pension expenses, potentially freeing up financial resources for States grappling with budgetary constraints or seeking to allocate funds to critical sectors like healthcare, education, and infrastructure.
However, the real complexity arises when evaluating the enduring fiscal consequences of such a transition. The RBI study on the fiscal impact of States reverting to OPS showed that the cumulative pension burden under OPS could be as much as 4.5 times greater than that under NPS. This substantial disparity is expected to accumulate over the period spanning from 2023 to 2084.
If States move to OPS in 2023, the supplementary pension burden will gradually intensify in the subsequent years, surpassing the NPS contributions by the 2030s.
These findings give rise to concerns regarding the sustainability of this transition. While OPS may provide immediate relief in terms of reduced costs, the study posits that these near-term advantages may be overshadowed by the mounting unfunded pension obligations in the long term.
Consequently, there exists the potential for escalating fiscal strain to unsustainable levels over the medium to long term. However, forecasting future pension outlays is complicated due to fluctuating factors such as interest rates, longevity, and salary/pension growth, which can affect risk premiums and capital costs in the economy.
India’s pension landscape aligns with global trends in fiscal responsibility, yet the recent inclination of States towards OPS raises complex challenges. The RBI report further emphasises the likelihood of significantly higher long-term pension obligations under OPS compared to the NPS. The decision should strike a balance between the social security of the retiree and the fiscal prudence of the State.
Saravanan is a professor of finance and accounting and Karthikeyan is a research staff at IIM Tiruchirappalli