On Sunset Boulevard

As if the disinvestment brake was not enough! For nearly 90 per cent of Indians not covered by a formal pension plan, there is more bad news. The government has decided to delay the decision on a reformed pension plan and its potential operators. With the earlier October 1 deadline scrapped, one cannot now expect any announcements before the next budget, if ever.

Officially, the finance ministry says the current fiscal mess is responsible for the decision being put off. That's surprising. One would have thought that since the ever-growing pensions liability of the government is only aggravating its financial troubles, reforms would make it easier for government finances to breathe! But there are wheels within wheels. So a seemingly straightforward issue—which, according to S.A. Dave, chairman of Project OASIS (Old Age Security and Income Scheme), is "merely a win-win situation for the government"—is caught in an insoluble tangle between different ministries and institutions and the favourite Indian occupation of delaying the inevitable.

The fact remains that pension reforms are as unavoidable as disinvestment. To begin with, they are a huge liability on governments—both central and state—which are forced to contribute fixed sums for schemes run for their employees. The schemes offer brilliant returns but give very little freedom to the government's fund managers as far as investment options go. As a result, losses are mounting. So could the grand pension castle come crashing down any day, like the US-64 scheme that was once considered a perfectly safe investment option? The answer is frightening. The Reserve Bank of India feels this could happen within 10 years at the most for central schemes, and much earlier for the state ones.

The pension reforms process started four years ago in August 1998, when the ministry of social justice and empowerment asked the committee headed by Dave to flesh out a full pension reforms policy. The famed oasis report was submitted to the Insurance Regulatory and Development Authority (IRDA). In April 2001 came the World Bank's report, 'India: The challenge of Old Age Income Security'. The International Monetary Fund followed with 'Pension Reforms in India' in September the same year. There was also an ADB study of the Employees' Provident Fund Organisation that runs schemes for non-government employees totalling around 26 million. Finally, there was the B.K. Bhattacharya committee which has submitted its suggestions on new pension schemes for government employees as also the feasibility of the entry of private players to handle pension funds.

In this surfeit of recommendations, there were two crucial ones. One, to reduce government liability in pension schemes for government employees by moving towards the defined contribution (DC) system which the private sector uses, where contributions by both the employees and the employers are fixed. Indeed, the world over, pension systems are moving to DC systems that are more sustainable and profitable to the employee. But pensions in India remain a dog-eat-tail, pay-as-you-go system. For civil servants, it's an unfunded, defined-benefit system, that is, the government entirely funds the pension schemes for its staff, without any contribution from the latter. In other words, pension payments each year are funded out of current taxes and is a reward for service to government, along with general PF, gratuity and a whole lot of fringe benefits. If government servants are asked to contribute, it will reduce the government's burden by similar amounts. In addition, experts want private sector professionals to be allowed to manage some of the funds. The two strategies in conjunction could easily make existing pension schemes more sustainable as well as profitable.

However, due to the government's dilly-dallying, there are still no schemes, no signs of a regulatory authority, no idea on who the private sector fund managers could be—insurance companies, mutual funds or banks. And of course, where all the money is going to come from. So the time bomb keeps ticking away, while the pension bill of civil servants (11 million at the Centre and states) has touched 27 per cent of their total wage bill and average pension per individual is almost half the wages, according to a study by Mukul Asher, professor, Public Policy Programme, National University of Singapore. As the number of those over 60 years climbs steadily to about 20 per cent of the total population by 2022, the government is likely to be saddled with astronomical liabilities. At present, even according to the World Bank's optimistic estimates, the implied public debt due to the Employees' Provident Fund (EPF) and the Employees' Provident Scheme (eps) amounts to nearly 33 per cent of GDP.

Bhattacharya too estimates the unfunded pension liabilities of the government to be one-third of GDP, while Manish Sabherwal, managing director, India Life Hewitt, feels it would be closer to 40 per cent, or Rs 6,00,000 crore. Estimates made by oasis show that the Centre alone would need to shell out over Rs 27,000 crore towards pension payments in 2015. Says Shashank Saksena, joint director, ministry of finance: "Globally, countries are struggling to contain the contingent liability in the form of future pension outlays. Such liabilities could (easily) lead to drastic downgrading of (sovereign) credit ratings." The situation is so serious that Asher feels that even if the government reforms the existing system, net reduction in its pension liabilities may only come into effect after four decades.

A critical shortcoming of the current system is the manner in which these funds are being invested. To cite just one example, in the last decade, EPF in India earned an annual average return of 2.5 per cent over the rate of inflation as against the figure of 11 per cent in the case of Chile. This, in spite of the fact that at 25 per cent of pay, India's contribution is the highest in the world. Compare these measly returns with the fact that a recurring investment of Rs 5 every day into the equity index between the age of 25 and 60 could yield a whopping Rs 36 lakh. So, says Ajay Shah, advisor in the finance ministry and Project oasis associate, pension funds—which invest only in government securities and prescribed bonds—should be allowed to invest in equity markets for the best returns. He also feels that mutual funds should be allowed to manage the emerging market given the fact that it is the only sector that's well managed and effectively regulated.

The entry of the private sector in pension funds will also have other indirect benefits. For instance, the new competitors could take pension planning to poorer workers in the unorganised sector. At present, the only scheme available to them is the Public Provident Fund (PPF), which allows minimum contributions of Rs 100 but is only up to 15 years. Obviously, after 15 years, the employee would need to reinvest the money, a step that can increase risks and possibly erode the value of the corpus. The entry of global pension funds could also solve problems relating to shortage of infrastructure financing as they could be forced to invest a part of their corpus in such areas.

So, what stops the government from doing so? Officials at the finance ministry contend that the Unit Trust of India (UTI) mismanagement and depressed stockmarkets have put spanners in the works. While several mutual fund schemes run by UTI have gone bust, private players have been unable to show decent returns.The other obstacle is the irda. It has argued that pension funds should come under its ambit since this business is closer to insurance than to active fund management. That sounds a bit odd since, in the US, pension funds constitute almost a third of the mutual funds' corpus of $7 trillion.

The need of the hour is to get started anyhow but ministries would rather wrangle even as the security of their precious schemes gets eroded. Most experts feel the eps should be scrapped as the probability of its devolvement on the Centre is very high. The EPF has, over the years, turned out to be a convenient source of funds for state governments and the likelihood of their going bankrupt thanks to rising guarantees increases by the day. For PPF and EPF, there are only two possibilities: the returns will steadily go down or they will collapse under the weight of unrealistic assured returns of 9.5 per cent plus. The last—the General Provident Fund, which is what the civil servants enjoy, in its present form, will steadily impoverish the nation. Too much fire here for our policy-makers to be playing around with, isn't it?