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Gopal Das, Sushma Devi and India’s Pension Reforms

Omkar Goswami


Anyone familiar with India’s demographic trends ought to be in favour of pensions reform. Decline in the death rate over the last few decades has led to a marked increase in the number of people aged 60 and above. There were 76 million such people in 2001 and, according to the UN projections, this is set to explode to over 142 million by 2021. The longer retired people live, the greater is the strain on any pension system.


To be sure, the schemes of the central and state governments, the railways, the myriad public sector undertakings and the armed forces cover a small fraction of our population. Nevertheless, it is huge in numbers. For instance, the pension liability of the Central Government alone has been growing at over 15 per cent per annum. In 2004-05, it will amount to something close to Rs.27,000 crore, or 1.7 per cent of GDP. That excludes the pension liabilities of Indian Railways — where matters are already very grave. With a staff strength of 1.54 million, the Railways already supports 1.13 million pensioners. By 2006-07, pensioners will exceed the number of Railways staff. It is not surprising that pension payout of the Railways accounts for almost 15 per cent of its gross revenues.The situation is worse in the states — because each not only has a bloated bureaucracy but also most don’t have the income to pay salaries leave alone pensions.


Worse still, the existing pensions are based on defined benefit schemes: existing sarkari employees contribute each month, the government puts in its equal bit, and the system assures everyone of a defined, sure-shot return when they retire. Since every such scheme is based on artificially high, untenable rates of interest, the system is like a Ponzi — where states draw out unsustainable amounts out of current contributions to pay pensioners. Clearly, if these were to continue, they would bankrupt the states as well as the centre. International experience uniformly shows that defined benefit schemes are eventually unviable.


Therefore, nobody can disagree with the urgent need for pensions reform — and that, going forward, it should a defined contribution and not a defined benefit scheme. My discomfiture is with the way in which the new system is supposed to be structured. Let me explain, and then pose the critique.


As of now, the proposed scheme applies only to new central government employees, and excludes the armed forces, the Railways and the state government. Sooner or later, these  will also be included. Here’s the scheme:


  • From 2004, all new entrants to the central civil service will contribute 10 per cent of their basic and DA, with matching contribution from government; however neither the government nor the pensions administrators will promise an administered interest, or a defined benefit at retirement. That will vary according to  a contributor’s appetite for risk and skills of the pension fund managers.

  • An independent Pensions Regulatory and Development Authority (PRDA) has come into play to regulate the sector. The PRDA will choose a set of pension fund managers.

  • Each contributor will choose a fund manager, and opt for one of three types of pension portfolios — pure equity, pure debt, or a balanced fund — with the proviso to switch from one to another during the life cycle.

  • All contributions and their records will be routed to the pension fund managers via a Central Record-keeping Agency which, through scale, will hopefully reduce transaction costs.

  • At 60, the contributor will have to purchase an annuity from any registered life insurance company of at least 40 per cent of the accumulated corpus. Beyond that, s(he) will receive a lump-sum of accumulated pension.


Very sensible in principle. Now let us switch to Gopal Das, a new Class IV central government employee at the Planning Commission, Sushma Devi, a teacher at a municipal primary school, and Lance Naik Pritam Singh — people who form the backbone of India’s government service. Here are my questions.


How many supposedly “intelligent” investors such as you and I can truly claim to have made “informed” choices between pure debt, pure equity and balanced funds? How many of us look at a daily, even weekly, basis at our fund’s changing net asset value to make  income maximising portfolio choices? The straight answer is that, much as we pretend to know about mutual funds, the hurly burly of everyday life precludes us from being concentrated savings maximisers. By the way, that’s precisely why banks make money out of you and me.


So, if we really don’t know a fig about these things, why should we expect Gopal, Sushma and Pritam to first choose between debt, equity and balanced, and then keep checking fund performance and NAVs to do intelligent switches that maximise the net present value across complex inter-temporal income streams?


The proponents of the fund-based scheme will tell you that they needn’t — and that internationally trained, customer-sensitive pension fund managers will do it for them. My answer to that is, “Bosh!”. Take the entire slew of equity based mutual funds in India, and ask a simple question: Which one has continuously out-performed a “monkey” portfolio of 30 randomly chosen Group A and B1 stocks? Why should Gopal Das, Sushma Devi and Pritam Singh — whose pensions will constitute their most significant savings — rely only on those who haven’t exactly covered themselves with glory. You and I, what with our RBI bonds, can play around with mutual funds, pretending that we know our NAVs and can switch from one to another with great felicity. Is that a fair assumption to make about our trio?


More importantly, what about the political repercussions that could happen if a pension fund happens to lose the capital of Class IV employees? That’s the time when Sitaram Yechury’s bite will truly be far worse than his bark. For the new pensions experiment to succeed, its time to realise that Gopal Das, Sushma Devi and Pritam Singh want a modicum of safety to protect their capital. Therefore, it is time to think of having annuity-based insurance products as a part of the portfolio, managed by insurance companies. Let the unit-based mutual funds cater to those who can take higher risks. But, for the sake of viable pensions reform, let’s think of protecting our Gopals, Sushmas and Pritams, without assured benefits. Remember, they can make or break this much-needed reform.


Published: Financial Express, October 2004


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