In 2019, I wrote
a critical analysis of how the pension schemes promoted by the Central government (such as the Atal Pension Yojana (APY), or the Pradhan Mantri Shram Yogi Maandhan (PM-SYM) were moving in the opposite direction from the pre-decided trajectory in 2003 when the new (now national) pension scheme (NPS) was launched. Some of the reservations expressed at that time have come true in 2022. It was noted that defined benefit-defined contribution (DB-DC) type schemes such as the APY and PM-SMY invariably run into trouble.
In November 2021. it was reported
that the Indian government is likely to start a ‘donate pension’ campaign to bridge the funding gap in line with the surrendering of the liquid petroleum gas (LPG) subsidy. One must admit that it is a unique way of organising solidarity and is unheard of in literature.
However, the issue is no longer restricted to voluntary Pillar-III pension schemes (to use the World Bank's terminology); it has now moved to Pillar-I scheme—the very genesis of the pension sector reforms in India in the 2000s.
The Pillar-I schemes in India consists of the civil services pension scheme which is designed as pay-as-you-go defined benefit schemes (PAYG-DB). Various committee reports, starting from the Dave Committee report, 1999, recommended that this social security arrangement be discontinued and instead a defined contribution scheme (DC) be started. The rationale for these recommendations was that pension and provident fund arrangements in Central and state governments can strain future finances.
Accordingly, reforms in India were modelled in line with happenings in Chile, Argentina and others under the initiative by the World Bank at that time. Thus, all new Central government recruitments after a date around 2004 were enrolled in the NPS. Subsequently, the state government also followed suit, albeit at a different point in time.
Then around 2007, the public sector banks (PSBs) also phased out their DB pension plans and moved to NPS under the corporate plan. The same NPS is also now open to all citizens and is regulated by Pension Fund Regulatory and Development Authority (PFRDA) and its funds are managed by designated fund houses that PFRDA periodically selects.
The immediate issue that has motivated this article is the announcement made by the Rajasthan government to implement the old pension scheme (i.e., PAYG-DB) for state government employees who were appointed on or after 1 January 2004. The suggestion is no more localised to Rajasthan and is gaining traction in Himachal
Pradesh and Haryana
. Samajwadi Party has made a similar promise related to the old pension scheme in the election manifesto for Uttar Pradesh.
The Reserve Bank of India (RBI) investigated the issues concerning state government pension liability. RBI constituted a study group (BK Bhattacharya, 2003) in the light of the sharp fiscal deterioration of state governments. This group noted that the pension liabilities of the state governments have considerably increased on account of recommendations emanating from the fifth pay commission. Pension liabilities are also high because the state pension scheme covers not only the civil servants but also the grant-in-aid institutions, local bodies and Panchayati raj institutions. The legacy burden of the existing PAYG will be carried for the next 35-40 years. Hence, the introduction of pure DC will not help relieve the fiscal burden. Therefore, some parametric changes are required in the existing PAYG of the state governments.
The reintroduction of PAYG-DA even before the legacy burden is nullified is bound to increase the current expenditure of any state that decides to migrate to the old arrangement from a retrospective effect in 2022. The latest RBI report on state finance states that pension liability constitutes roughly 11%-12% of the revenue expenditure. Further, this liability will grow with inflation, the changes made by the subsequent pay commissions and the trends in longevity.
However, other important questions are connected with this rather radical U-turn on the state pension reforms.
First is the issue of the quality of public service itself. The BK Bhattacharya committee on the new pension system, 2001 recognised, among other things, the impact of the DC scheme on the honesty and integrity of the civil servant. Every other committee largely missed the interaction of pension schemes with the overall efficiency of civil servants on this subject. Reverting to the old system can have a negative impact on the overall quality of public service at the state and lower levels of the government machinery.
Second, the issue of management of funds collected under the NPS trust. The funds under the NPS are pooled under the NPS trust and allocated to fund managers for generating higher returns. Roughly Rs6.85 lakh crore is under the management, of which Rs3.54 lakh crore is the share of various state governments.
In the event of a switch to the old scheme, what will happen to this fund and how it will be used to match new PAYG-DB liability needs to be worked out and will depend upon many factors such as the promised benefits, date of implementation, the age profile of the cohort covered, and the funding structure adopted—partially funded or fully unfunded etc.
However, one thing is certain. When a switch to the old scheme happens, the respective state government will not contribute to the NPS trust and the rate of contribution in the trust will drop. It can be shown mathematically that the rate of return of the DC fund is dependent on the temporal growth of the contribution, besides the market rate of return. Thus, the overall return of the NPS fund will reduce over time if more states join the bandwagon. Furthermore, many questions remain unanswered.
How will this settlement happen – by way of cash, transfer of security or mix of both? What will be the sharing mechanism of Rs549 crore of non-performing assets (NPAs) as of March 2021? If we add up all these factors, withdrawal by the states will, in effect, cross-subsidies the state government employees at the expense of the Central government employees and the corporate sector participants.
Third, there are at least two questions from the point of view of law. Does the PFRDA Act permit the withdrawal by state government at any point in the future? Two, how will the decision fare the test of Article 293 (1) & (2) of the Constitution of India, which governs the borrowing by states and Article 41, Directive Principles of State Policy, which binds the state to facilitate the provision of old-age income within the limits of economic capacity?
This decision constitutes borrowing and follows from the very nature of the PAYG system wherein one segment of the population is taxed/debt issued to pay pension to another segment. Thus, ex nihilo creation of liability creates what is known as the implicit pension debt.
In conclusion, what is transpiring regarding pension reforms at the state level has not come as a surprise to this author. This is partly because these types of reforms have seen a backlash even in Latin America after some time. Argentina reversed its multi-pillar policy in 2008 under a presidential order and reverted to the old PAYG type system after nearly two decades.
From an India point of view, this type of decision will have consequences on the optics and macroeconomic sides. On the optics, it is a setback to reforms that started in the 1990s. On the macroeconomic side, it will impact gross savings, spreads on state development loans, liquidity in gilts markets—to mention a few. A pension policy in the doldrums is not a good sign from the point of view of India @2047.
(The author is an economist in the banking system. The views expressed here are personal)