New
Pension Scheme
On January 1, 2004, Government Of India (GOI) has
introduced the New Pension Scheme (NPS) for the new
entrants to the service of the Central Government
(other than Armed Forces). NPS is a Defined Contribution
Scheme (DPS). The contribution rate is 10 per cent
of the gross salary for the employee: the employer
would also make an equal contribution to the employee’s
individual pension account. There would be no pre-retirement
withdrawal. The member has the option to allocate
the fund among a limited number of investment schemes.
At age 60, the accumulated amount would be divided
into a compulsory annuity component and a lump sum
withdrawal component. The sum that the pensioner would
receive as pension or as lump sum post retirement
money would depend on the yield rate of the scheme(s)
the individual had opted for.
The pension account under NPS is portable. If the
individual joins a new service, the account would
be shifted to his new office. The NPS thus facilitates
labour mobility. About the investment options, one
may observe that the GOI is now offering three options.
The options differ on the earmarked proportion of
investment in assured income instrument and equities.
The individual will exercise his option(s) depending
on his individual risk taking behaviour. (GOI is planning
to introduce a fourth option where hundred per cent
investment would be on government securities.)
Besides the Central Government, 19 provincial governments
of India have introduced the NPS. Notable exceptions
are three left ruled states, namely, West Bengal,
Tripura and Kerala. In fact, the Left Front has opposed
the New Pension Bill (Pension Fund Regulatory and
Development Authority Bill, 2005) that seeks the approval
of the Parliament for setting up a Pension Fund Regulatory
and Development Authority (PFRDA) that could manage
the pension fund and NPS. Due to the opposition of
the Left, the bill has not been placed in the Parliament
and the NPS for the central government employees is
still being executed on the basis of an ordinance.
However, the financial experts are of the opinion
that in spite of the opposition from the Left, various
public sector enterprises and the statutory boards
and government aided institutions are also likely
to join the NPS. Even the self employed persons whose
usual vehicle for savings is Public Provident Fund
might also join this scheme. This is so, because,
as the financial experts opine, investments under
NPS would yield a better return than the existing
pension scheme.
This point needs elaboration. According to the financial
experts, the investment under NPS which has an equity
component is expected to perform better because, as
the past records indicate, return on equities is much
higher than any guaranteed return scheme. In India,
equity indexed returns data is available for 28.5
years. The nominal rate of return on index fund is
18.5 per cent (less of dividend; with dividend, it
would be close to 19.5 per cent). The financial experts
think that over next thirty years, the inflation might
be around 3 per cent; short term government bonds
might yield around 4 per cent and index fund might
yield roughly 12 per cent. A superior return on equity
indexed fund, as they say, is thus assured. There
would therefore be a strong opinion in favour of the
NPS among a large section of the informed people.
As they plan their retirement scheme, they would strongly
support the new scheme. The NPS is therefore expected
to become popular among income earners in India in
near future. They would accept the scheme voluntarily,
in spite of the opposition from the Left. NPS and
the New Concept of Social Security.
I f the expected return under NPS is much higher than
the return under existing Defined Benefit Scheme (DBS),
why does not the government allow the members of the
Armed Forces to exercise this option? It is not true
that the Government does not care for the members
of the Armed Forces. In fact, they are the most valued
functionaries of the state as any body having any
knowledge about how the state functions, would agree.
That the members of the Armed Forces are being kept
under DBF does indicate that there is something shady
in the argument that NPS would earn better; at least
the government itself is not convinced that NPS would
give better benefits to its employees. Otherwise,
why would it keep its most valued members outside
this Scheme? In fact, there are problems with the
expected return of a equity-linked financial instrument.
One can never be sure that the returns from equities
would always be better than the guaranteed returns.
We would take up this issue in the later part of this
article. But the background of the NPS should be discussed
first.
NPS is based on a new concept of social security which
is a part of neo-liberal economic doctrine. NPS is
a defined contribution scheme without a defined and
assured benefit. It is radically different from the
existing scheme that ensures a defined benefit from
the employee without asking for a collateral contribution
from the employee. For the government employees and
a large section of the quasi-government employees
such a social security scheme has evolved over time.
The scheme offers a defined benefit in terms of fifty
per cent of past salary of the employees (or average
of last ten month’s salaries) as pension (with the
provision for commutation of a part of pension) and
gratuity of a lump sum amount. The employee is not
supposed to make any contribution except for provident
fund benefit which would be an added benefit in the
form of an assured return (presently 8 per cent) on
the contribution of the employee. The spirit behind
the defined contribution as aptly described in the
Report of the 4th Pay Commission of the Central Government
is that it is not a charity or an ex-gratia payment,
or a purely social welfare measure. It is in the nature
a ‘right’ which is enforced by the law of the land.
Indian Supreme Court also upheld that it is a right
based benefit that the state shall have to honour.
While advocating for its replacement by a so-called
better scheme, one should not ignore the fact that
social security in the form of defined benefit is
a right which is being denied by the very concept
of NPS.
The implication is quite deep. It is not without reason
that a defined benefit, the provision for which has
to be made by the state, was introduced in various
countries of the world from the end of the nineteenth
century. This was associated with the concept of rights
of the citizens of a nation state. In a nation state
the citizens are not perceived as subjects, they are
considered as the members of the society. As members
of the society, they are supposed to have a right
to live with dignity even after they retire from service.
The society has to take care of the retired persons
because the society is the beneficiary of the past
contributions of these citizens. Since the society
is represented by the state, the state has to take
the responsibility of looking after the senior citizens
so that they can live with dignity even when they
cannot earn their livelihood by participating in the
workforce. When the Old Age Pension Scheme was introduced
in Denmark in 1891 and in New Zealand in 1898 or in
the USA by Franklin Delano Roosevelt (1935) this was
the guiding spirit. This spirit was gradually accepted
by other nation states including France, Germany and
Great Britain. Although the social security measures
in these countries were not as comprehensive as in
the Soviet Union, the basic spirit that the society
has to bear the responsibility of ensuring the right
of a citizen to live with dignity even after (s)he
retires from the workforce had been upheld by the
modern capitalist states. In India, NP limitations
notwithstanding, the responsibility of providing retirement
benefits was borne by the state following the same
guiding principle, namely, that such measures were
based on the rights of the senior citizens. In no
way these were conceived as the act of charity by
a benevolent state. It is true that a large section
of the members of the workforce, particularly, the
unorganized labour in India have been denied this
right. But that does not mean that such rights are
to be denied for the organized workforce, as well.
It only provides a strong argument in favour of extending
this right to the excluded members of the workforce,
as well.
If a right is denied, the loss is something that cannot
be compensated by introducing a so called better retirement
benefit scheme because right of a citizen is non negotiable.
The neo-liberals who argue that a defined contribution
scheme is better than a defined benefit scheme ignore
this basic point. One should never forget that such
a right has been earned by the members of the society
after a long struggle from ensuring a life with dignity
in a capitalist world. Life without such a right can
never be a better one, whatever be the economic rational,
behind the alternative arrangement.
Economics of NPS
NPS is based on the idea that the state should not
be ‘burdened’ with the responsibility of providing
retirement benefit to its employees. This is consistent
with the neo-liberal view on the role of the state
in the economy of a nation. According to the neo-liberals,
economy should be ruled by the market forces to the
extent the market mitigated transactions can cover
the economic activities of the society. Since right
based benefits are not consistent with the market
mitigated benefits with respect to the retired members
of the workforce, as an employer the state shall have
to redefine the scope of retirement benefit so that
it can be translated in the language of market economy.
As the neo-liberals argue, there is no economic rational
behind a defined benefit which burdens the state with
the responsibility of mobilizing funds by taxing the
people for meeting the commitments of pension at a
defined rate. In fact, the scheme might become unsustainable
if the state is to maintain fiscal discipline so that
the inflation remains controlled and the tax rate
does not become regressive. As the economy opens up,
maintaining the fiscal discipline and keeping the
tax rates at par with international norm becomes necessary.
Under such a situation, it would be advisable to replace
the defined benefit scheme by the defined contribution
scheme which creates a provision for retirement benefit
out of the present income of the employee (and a contribution
from the state out of its present revenue) so that
the rules of sound finance are maintained. This is
more rational as well since it does not shift any
burden from one generation to the other at the cost
of violating the equity-based social justice. Since
the liability of an assured benefit will not be there
the state budget will not be put under pressure for
meeting a commitment that does not have a collateral
financial provision. The retired employee may also
earn a higher benefit if the pension fund is invested
judiciously. This is exactly the advice of the IMF
on Pension Reforms in India (IMF Working Paper on
Pension Reforms in India, September, 2001) and this
is what is being practiced in many Latin American
countries.
While introducing the NPS, Mr. Chidambaram, the Finance
Minister of the UPA Government had argued in the same
way as one would find in the IMF Report (2001). Briefly
speaking, the argument is that DBS is unsustainable
because the pension expenditure is increasing at a
very high rate. Thus, over 1993-94 to 2004-05, the
pension expenditure of the GOI has increased by 21
per cent; for the state governments, the rate of increase
is still higher (27 per cent over the same period).
What Mr. Chidambaram did not mention is that the government’s
pension expenses as a percentage of GDP is quite negligible
in India (less than 0.1 per cent). In South Korea
or in Hongkong it is about 2 per cent. In Italy, France
and Germany where the coverage under DBS pension is
wide, the pension expenses as percentage of GDP is
much higher in these countries. In Italy it is 14
per cent; in France and Germany the ratio is 12 per
cent. In Japan 9 per cent of the GDP is spent on DBS
pension. One wonders how it becomes unsustainable
in India where the expenses on DBS pension is so low.
Moreover, Mr. Chidambaram is heading the Finance Department
of a government which claims to have achieved a high
rate of success in moping up additional untapped tax
revenue. Tax revenue is also increasing for the state
governments after the introduction of VAT. From the
historic growth rate of 12 per cent (in case of sales
tax) it has now jumped to 20 per cent per year. The
Finance Minister of West Bengal in the recent meeting
of the Chief Ministers and State Finance Ministers
on NPS, has pointed out that the pension tax revenue
ratio is bound to decline over time in West Bengal
even if the DBS pension increases at 15 per cent (instead
of 10 per cent as on now) and the tax revenue increases
not at 20 per cent but at 18 per cent. The pension-tax
ratio would decline in that case to 9.6 per cent in
next 30 years. The Finance Minister also observed
that it might decrease even to a lower percentage
(5.7) if the tax revenue of the state increases by
20 per cent per year. For the GOI and the other state
governments, the trend should not be different given
that the economy is now growing at 8-9 per cent per
year. The argument that DBS would render all governments
‘bankrupt’ thus appears to be untenable.
The rationale of replacing DBS with DCS is elsewhere.
Following the financial sector liberalization, the
neo-liberals are targeting the huge financial assets
that should be there as corpus for creating the provision
of retirement benefit. All over the globe, such funds
are increasingly being driven to the global equity
market. In India paying pension under DBS does not
require a corpus to back it. Only asset related to
retirement benefit in India is the Employees Provident
Fund which is collected from the employees of 181
designated industries (including service industries)
employing more than 20 workers. This is ensured by
the Employees Provident Fund Act (1952). The fund
collected under this Act is under the control of Employees
Provident Fund Organisation (EPFO) which is autonomous
in nature. The Chairman of EPFO is the Central Labour
Minister, the board of governments of EPFO consists
of 45 members which includes the representatives of
the employees. EPFO rules over a fund of Rs. 170,
000 crores. The fund is huge. But the existing guidelines
of the EPFO provides for investment in debt instruments
only and even these are almost fully in the public
sector organizations. The EPFO provides an assured
return (now 8 per cent) which, as the neo-liberals
observe, does not follow any market rule. They do
not approve these investment guidelines which they
considered to be inefficient. As they argue, a prudent
mix of equity and debt in the investment portfolio
might have yielded a better return, had the fund been
linked with global capital market. The EPFO is yet
to accept this suggestion.
The neo-liberals therefore find it necessary to introduce
a new retirement benefit scheme that would be able
to mobilize a part of the saving of the income earners
in India for creating a pension fund that would be
driven to the global capital market. Since the size
of the income earners in India is huge, the corpus
would also be huge even if the wages and emoluments
remain low in this country. A defined Contribution
Scheme involving the government employees who would
have to pay 10 per cent of their gross salary and
a matching contribution from the government is considered
to be the beginning of this exercise. The participation
of Indian capital in global capital market would thereby
get a good start and integrating Indian capital market
with the global capital market would be furthered.
The benefit, as they argue, would be both for the
investors and the government. The government will
be relived of the responsibility of mobilizing revenue
for meeting the pension commitments for its ever growing
number of retired employees under DBS. The investors
(the employees) would also get the benefit of higher
return from the global equity market. As they think,
it would be a win-win situation.
Equity Market and Finance
Capital
One should however note that the global capital market
is volatile and there are cases when a country faced
fiscal collapse due to the volatility in global capital
market. As Joseph Striglitz observed, ‘America and
world should remember Argentina’s privatization was
at the centre of its fiscal collapse’. There are reasons
to believe that a participation in global equity market
might become counter productive for the weak participants
with limited rationality and without having the backup
of a powerful economy that might bail it out in case
the crisis develops.
The advocates of pension fund liberalization expect
equity indexed future return of 12 per cent which
would be much higher than the future expected returns
on bonds. These are based on the past performance
of equity indexed instruments in India and the long
run behaviour of inflation rate and the real rate
of returns on bonds. What they do not mention is that
the past performances should not be taken as a reliable
guide, particularly in this context, because the Indian
capital market remained mostly insular to global capital
during a large part of 28 years when the nominal return
from equity indexed instruments had been as high as
18.5 per cent. As the market is integrated with the
global capital, the return is expected to come down
to 9 per cent which is the ruling rate of return in
the global equity market. The speculation that the
investment in equity indexed fund would earn a 12
per cent rate of return does not appear to be based
on the existing reality in global capital market.
Again the cost of services for the global fund management
companies is much higher than what we experience now
in India. Since the cost of fund management has to
be borne out of the returns on equities, the net return
for the investors might not be as high as the neo-liberals
predict. In fact, the difference between the yields
from equity market and the bond market might not be
as high as the experts claim during even the normal
period of business. In case of business run, which
is not uncommon in equity market the return might
be even lower. This is the experience of the global
capital market. As Kindleberger has pointed out, crisis
in the financial market is quite a common experience
in the 400 years of financial history of Europe.
Finally, why should the small pensioners who usually
do not have savings to tide over the crisis should
be driven to such a situation? The answer might be
that the global capital does not have any moral obligation
to honour the right of the citizen to live with dignity
even in the retired life.
