Even if the Act is passed, the NPS is full of holes

The Pension Fund Regulatory and Development Authority (PFRDA) Bill is about to be converted into an Act. On 30 August 2011, the Standing Committee on Finance, headed by Yashwant Sinha, former finance minister, presented the Bill to the Lok Sabha after a lot of changes and suggestions. However, it is not certain whether the New Pension System (NPS) will achieve its basic purpose, after the Bill is passed.

For instance, returns from the NPS for Central government employees, has been anything but smooth. It has ranged between 16.38% (State Bank of India, SBI) and 8.05% (SBI) during the period from 2008-09 to 2010-11. In contrast, the Employees’ Provident Fund Organisation (EPFO) has declared rate of return for subscribers to the Employees’ Provident Fund (EPF) at the rate of 8.5% for the year 2008-09 and 2009-10 and 9.5% for 2010-11—although by a sleight of hand.

Now, we know that investors shun volatility. There is limited participation in mutual funds due to the very same reason. Certain mutual funds may have a tremendous track record (giving yearly compounded returns of 22% since inception); yet, investments in these funds are low because Indian investors look for investments with guaranteed returns.

Therefore, without adequate investor literacy and handholding, it would be difficult to get investors to participate in the NPS or any other market-linked investment product. As mentioned by the Committee, “It requires a huge educational and awareness effort to inform and enthuse the workers to join a pension system with no easy withdrawal benefits for 30-40 years.”

So it is not a surprise that from the unorganised sector, only around 0.3 million subscribers have so far joined the ‘Swavalamban’ pension scheme, and that only around 51,000 have joined the voluntary part of the NPS so far.

The committee is rightly concerned about volatility of returns vis-à-vis the old pension system, under which a retiree is guaranteed a monthly pension amounting to 50% of the average of the pay drawn in the last ten months of service and the facility of commutation.

The Committee has proposed that the investment guidelines should be framed by PFRDA in such a manner that, besides the other financial instruments, an option would be given to the subscribers of the NPS where 100% investment in government securities would be permitted. This would be similar to bank fixed deposits for investors as they would earn interest along with capital protection. How far this would influence participation still remains a big question.

Withdrawal Flexibility
A big problem of NPS is that it provides for a ‘non-withdrawable’ and compulsory Tier-I account and a voluntary Tier-II account. Anyone who wants a ‘withdrawable’ facility has to opt for the Tier-II option also. This is messy. The Committee, therefore, suggests that even in the case of a Tier-I account, an element of flexibility should be provided under the NPS to enable subscribers to withdraw funds to meet unforeseen and urgent expenses. For instance, subscribers could be allowed to take one repayable advance from their accounts after completion of 15 years of service and also permanently withdraw up to 50% of their contribution after completion of a minimum of 25 years of service to meet expenses on exigencies which should be appropriately listed by regulations.

While laudable, wouldn’t this introduce an element of arbitrariness? India is famous for red-tape and corruption. This regulation would just put an additional burden on the investors who wish to withdraw from their fund. Instead, the Committee should have suggested a minimum percentage of withdrawal from the Fund for a particular period. This would have been easier to understand and implement.