Themes > Current Issues
29.09.2007
Social Security Benefits and the New Pension Scheme
Ratan Khasnabis
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.
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.
© MACROSCAN 2007