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Pensions must be reinvented
Bharat Jhunjhunwala on why pension reform should not be delayed any further
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Illustration: Sanjoy Naorem |
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ONE OF the factors contributing to the deteriorating fiscal situation is the increasing burden of pensions. Until 2003, pension to government servants was paid by the ex-chequer — the employees themselves did not contribute towards it. A government servant who, for example, retired in 1990, would be paid pension from the current budgetary revenues of the government in 2012. So while the 1990 government used the services of the servant, it passed on the pension liability of that usage to future governments. The Union and state governments spent 4.1 percent of their revenue towards payment of pensions in 1990. This increased to 7.2 percent in 2009. These are not small amounts: For instance, the total expenditure on health and social welfare of 120 crore citizens was less than that spent on pensions of few lakh retired government servants.
Then finance minister Yashwant Sinha had initiated a New Pension Scheme (NPS) in 2004 to limit this ever-increasing burden. All Union government employees recruited after 2004 are to get pension under this scheme. They have to contribute 10 percent of their salaries towards their pension fund, with the Union government providing a matching amount. The NPS makes a radical departure from past practice. Previously, the amount of pension was determined by the present salary structure as advised by the Pay Commission. The NPS does away with a determined amount of pension. The amount accumulated in the pension fund of the individual is used to provide pension. This varies with the amount accumulated.
There are some shortcomings in the NPS, however. First, that it covers only government servants. Ninety-five percent of the citizens are outside its coverage. Second, the pension fund is wholly being invested in government bonds which provide a low rate of return. The Chairman of the Pension Fund Regulatory Authority, D Swarup, says that the cost of managing these funds is high while the return is low. The UPA government has prepared a Bill to remove these shortcomings.
The Bill provides flexibility in investment of the fund. The beneficiary can choose a management agency from among many that may be registered for the purpose. At present, the entire corpus is managed by the State Bank of India. A beneficiary does not have the option of assigning management to another agency which may be able to garner better returns. Private as well as foreign entities are allowed to register themselves as fund managers under the new Bill. That will provide greater choice to the beneficiary. Foreign investors want the Bill to be passed expeditiously because they want to enter this huge market.
The Bill enables the beneficiary to take a higher risk and earn higher amounts as well. Currently, the entire amount is wholly invested in government securities. For certain category of beneficiaries, 5 percent is allowed in equities and 10 percent in mutual funds. Eighty-five percent has to necessarily be invested in government securities. The Bill provides that a beneficiary can instruct his chosen management agency to invest higher amounts in share markets. Pension funds are allowed to invest up to 60 percent in equities in the UK. While providing this choice is welcome, a word of caution is required. Pensioners in the US have lost about one-third of their payouts to the global recession. That said, this is not a shortcoming of the Bill, because beneficiaries are allowed to opt for the safer option of investing wholly in government securities.
The Bill allows private citizens to invest in the NPS. However, they will not be entitled to a matching grant by the government. There is provision for a small incentive to those investing less than Rs 12,000 per year. On the negative side, the returns from the NPS are taxable, making it less attractive than the Public Provident Fund, which is tax-free. Therefore, this provision in the Bill is likely to be a non-starter but it does not do any harm.
The Bill is being opposed mainly on the grounds that it does not provide a guaranteed return on the investments. A parliamentary committee under the chairmanship of Yashwant Sinha has recommended introduction of minimum guarantee. I do not think this is justified. Beneficiaries who want security and assured amount of pension may wholly invest their fund in government securities. They will get a specified income with marginal variation, if any. It is unfair for these security-minded beneficiaries to deprive other risk-taking beneficiaries from investing their funds in equities for higher returns.
ACTUALLY, GOVERNMENT employees want to get double benefits. They want the option to invest in equities so that they get higher returns; but they also want the government to ensure a minimum guarantee just in case they incur a loss. This means that the beneficiary keeps the profits; while the government bears the losses. This is unfair because the minimum guaranteed amount will ultimately come from taxpayers’ money. Two crore government servants who are already highly paid cannot be allowed to further bleed the aam aadmi.
Another argument against the Bill is that it does not provide adequate coverage for the unorganised sector. But all problems cannot be solved in one go.
The third objection to the Bill is that it allows the investment of sensitive pension fund in speculation in the share markets. Factually, this is correct. But the Bill only provides an alternative for investing in the share markets. Such investment can be made only if the beneficiary gives appropriate directions. There is no compulsion for investing in equities. Further, it is incorrect to brand the share markets as purely speculative and unproductive. The share markets help channel small amounts of hidden wealth into productive work. They also provide signals to bankers and other players about the health of a company.
A limitation of the Bill should also be mentioned. Commentators have suggested that the Bill will help control the fiscal deficit of the government. But this does not seem likely. The budget has already been firewalled from pension liability of new recruits to the government by the NPS. They are not to be paid pensions from the budget. Therefore, the Bill will have no impact on fiscal deficit. If at all, it may have a negative impact. The Bill will lead to diversion of part of the fund from government securities to equities. That will reduce the demand for securities and the government may have to offer higher interest rates to meet its borrowing targets. That will worsen the fiscal deficit due to increasing interest burden.
Bharat Jhunjhunwala is a former economics professor at IIM Bengaluru.
bharatjj@gmail.com
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