Union finance minister (FM) Nirmala Sitharaman last week announced the establishment of a committee headed by finance secretary TV Somanathan to review the new pension system amidst demands from a section of employees and the decision by some Opposition-governed states to revert to the old pension scheme. Among other things, one of the topics of interest for this committee is to explore the feasibility of the so-called ‘Andhra model’ of the guaranteed pension scheme (GPS) which was proposed in April 2022.
The Andhra model, as is reported in the media, has two broad proposals—one, the state government will give a guaranteed pension of 33% of the last drawn salary if the state government contributes 10% of the basic salary, a contribution equally matched by the government. The second proposal is a guaranteed pension of 40% of the last drawn salary if employees are willing to contribute a higher 14% which, again, will be equally matched by the state government. It is difficult to make out what minister of finance Buggana Rajendranath means when he says: “[m]arket conditions will have no influence on the pension under GPS which is nearly 70 per cent higher than the present pension being offered under CPS, in line with the present interest rates.”
The proposal sounds very convincing as both, the funding and the guarantee aspect, are transparently accounted for. Nonetheless, there are some pressing issues so far not addressed, which the to-be-formed committee headed by the finance secretary may take into consideration.
The list of pressing issues includes how this proposal will be organised. First, will the current architecture of the national pension system (NPS) be preserved or will it face another demand of withdrawal from the Andhra government to implement the GPS at the state level? Second, will the GPS be implemented on a prospective basis or retrospective basis as the demand to revert to the old pension scheme (OPS) is from the cohort that enrolled in 2004 and the funding of implicit pension debt on account of the proposed guarantee?
Third, the theoretical issue, whether the proposal is really a middle ground and will not be a burden on the fiscal position of the state.
On the first issue, it is not clear whether guaranteed defined benefit-defined contribution (DB-DC) GPS will be reconstituted at the state level by fully withdrawing from the NPS trust.
Another option that is also within possibility is that the state government tracks the replacement rate as realised under the 40% mandatory annuitisation of the NPS corpus of the respective state government employees enrolled under the NPS. Thus, depending on the replacement rate realised (say 27%) at the time of retirement, the state government can budget the balance (33% - 27% = 6%) and transfer it to the NPS trust under the 40% corpus as a top-up amount before annuitisation. Under this method, there is no need to withdraw from the NPS trust and the element of cross-
subsidisation highlighted by this author in his previous article is taken care of. Further, this proposal operates separately from the guaranteed return scheme of the pension fund regulatory & development authority (PFRDA) which is in the
pipeline.
However, the proposal still lacks an element of critical thinking. The proposal has two options. The 33% guarantee is against a contribution of 10% and the 40% guarantee, against a contribution of 14%. However, when NPS was launched in 2004, the employee contribution was fixed at 10%. Later, the Centre increased its share to 14% for its employees with full tax benefits. This 4% rise with full tax benefits was also extended to state government employees in the recent Finance Bill. The tax benefit of a 4% rise has not been extended to corporate participants so far.
Thus, if the proposal is from a retrospective effect, then the state government will have to make an upfront provision for the balance amount of contribution and ongoing retirements. Will past interest be paid from a retrospective effect is also an open question. The balance amount to be paid under the proposed replacement rate guaranteed will depend on the prospective or retrospective aspect of the proposal. Furthermore, will the tax benefit be extended to a 4% share from the employee as an incentive?
In any case, the larger issue is that the so-called national pension system now differentiates between different categories of its participants in the tier-1 scheme which is in gross violation of the right to equality as propounded by the constitutional bench in the Antulay case.
Theoretically speaking, to the mind of this author, the proposal is not a middle ground by any stretch of the imagination. Pension economics suggest that a defined benefit scheme can be viewed as a defined contribution scheme with an embedded put option. This option can be a guaranteed return or guaranteed replacement rate. In either case, the guarantor (state government) has to be paid a premium and who pays the premium decides whether the proposal “addresses needs of employees while maintaining fiscal prudence to protect common citizens,” as stated by the FM.
It can be shown theoretically that if the Andhra government introduces the GPS, then it has, in fact, engineered the old pension scheme (OPS) surreptitiously through the backdoor and the intergenerational consequences of a complete relapse to OPS are no different from the current proposal. This is because a guarantee is not a one-time affair but a binding constraint on the inter-temporal budget constraint of the state government. How this guarantee will be reckoned under FRBM (Fiscal Responsibility and Budget Management) Act is also not clear when states have moved under the GST (goods and services tax) regime by surrendering their rights to taxation under many heads.
In conclusion, reckless populism and an unprincipled approach to politics have created a very tricky situation that will jeopardise the fiscal burden of the Centre and the states combined. DB-DC schemes have never been sustainable and there is no doubt that this new DB-DC approach in the Andhra GPS model will also meet the same fate.
(The author is an economist in the banking system. The views expressed here are personal)
