Government Pension Funds Need More Lucrative Investment Avenues To Quell The Controversy Between Old And New Schemes

When the Vajpayee administration introduced the new pension system (NPS) for central and other government employees commencing on 1^st January 2004, the motivation was to ensure long-term viability. It is mandatory for the central government employees and a few other entities. Much greater longevity had complicated the calculations on the old pension system (OPS).

The threat of a bankrupt state defaulting on pensions, such as West Bengal, Kerala or Punjab today, was already beginning to loom large in 2003 when the NPS was formulated.

Punjab’s pension liability, as its AAP government plans to go back to the OPS system of 18 years ago, is unsustainable. In 2022-23, it is estimated at Rs 15, 146 crores, or one-third of state revenues of just Rs 45,588 crore for the year. Other commitments such as salary and interest on borrowings takes it to almost 50% over state revenues.

West Bengal, that has never adopted the NPS, says things are much better for the state’s finances after the implementation of Value Added Tax (VAT) and that its pension bill is only about 10% of state revenues. Others are sceptical of the state’s calculations because it is one of the most indebted states of the Indian union.

The OPS was already eating up 65% of India’s GDP basis 2006-2007, on a forward projected basis.  The calculation is called implicit pension debt (IPD), the net present value of future pension commitments. A study released by Gautam Bharadwaj co-founder and director of pinBox Solutions that has designed pension systems for Asia, Africa, Latin America,  the Caribbean regions, and first SEBI Chairman Surendra Dave put up the warning balloon in support of NPS. 

The attraction for the OPS, the demand for which has resurfaced in BJP ruled states ( Himachal Pradesh, Madhya Pradesh), as much as in opposition and Congress ruled states (Chhatisgarh, Jharkhand and Rajasthan have already reverted to OPS), is that it pays out a sure sum.

The OPS is calculated on 50% of last salary drawn plus dearness allowance based on the averaged earnings of the last ten months of service, adjusted every six months. There are no contributions required while in service and the system kicks in only on retirement.

The NPS calls for nearly equal, (10% for employees, and 14% for the government), but small contributions on a monthly basis, for all central government employees and other entities on the NPS.

If the employee dies while in service the accumulated benefits are given to the nominee. Like in LIC and some other insurance/mutual fund schemes, the employee can also borrow against his/her pension fund even while in service. While the corpus is invested in debt and equity per the employee’s preference, there is no guarantee on the quantum of retirement benefits. This, of course, is daunting for the risk averse.

Now a scheme is being worked out by the pension regulator PFRDA to provide a product that would give assured returns under NPS.

The criticism against the present NPS is that debt fund returns are fairly low at between 5-7.5% per annum compounded which does not even keep up with inflation. And the investments in equity, if chosen, are highly volatile. It is possible, as has been seen with mammoth pension funds in America, that retirement benefits accessed on superannuation are badly compromised by market forces despite long term retention, churning by the fund managers, and sometimes, bad bets.

So while the NPS may reduce government liabilities, it is not always good for the future pensioner. The way out may be for pension regulators to approve bank style lending in housing finance and other loans that can be charged out at 10%  p.a. or more against fixed tenures, repayable in EMIs, in a rising interest scenario, and less when the RBI cuts repo and other rates.

With a government guaranteed and run banking/NBFC operation the pensioners funds are not at the mercy of a volatile equity market or a low return debt market. Necessary legislation to accommodate this should be passed so that the funds are not necessarily parked/managed in Indian debt or equity.

If there are compounded returns of around 10% or more per annum on fixed term basis that run into 10 to 20 years, in housing finance, and lesser tenures for other kinds of lending, the pensioner is likely to find that the NPS is more lucrative than the OPS, and without being risky after all.

It will become a win-win situation for both the government and the pensioner. The need for detailed supervision and perpetually running audits will be important to avoid scams. Just making pensions paid out for employees who have joined the central government and other entities including states on the NPS is not enough, though most welcome.

To label the OPS as both bad politics for the Russian Roulette attitude to financial liability, and bad economics because of a burgeoning pension bill that detracts from and cuts into development funds is fine.

But it also calls for the NPS to behave more like a mortgage bank in the Western countries, so that all sides of the financial equation are addressed. Mortgage lenders in the West offer loans, rerate property values of its clients, help to arrange purchases and sales, provide credit and debit cards against the equity developed over the years.

Should our pension funds help people, the government employees, to buy one or more homes, shops, commercial premises? Should pension funds be provided to aatmanirbhar defence manufacturing long term at attractive rates of interest? Can it help the national objectives in multiple ways instead of just being relegated to a stock market that is dominated by billions of dollars in foreign institutional investment (FII) that come and go as it pleases leaving large waves in its wake?

The FII investment that comes into India is generally looking for arbitrage against funds procured at much lower interest rates abroad, and foreign currency versus rupee investment gains. The equity gains, if any, are further profits after all that.

The fact that FIIs can dominate the market with massive buy and sell orders mainly in the top line Sensex stocks makes it difficult for others to compete. While domestic investment in the stock market from institutional and retail operators is much bigger in quantum terms, it tends to stay put because it is largely promoter and investor money tied to equity holdings. None of the FIIs, even the ones with higher allocations to India, have really decided to invest in India long-term as yet. This may change, but not in a hurry. Many are still wedded to the Chinese stock market, because it is much bigger, despite its deep and increasing problems.

Imagination has never been encouraged much in government entities in India till lately. But now that it is, in unicorns and start-ups, in government-private manufacturing in defence industry, in the satellite building and launching business, in the harnessing of alternative energy, there can be niches found which are low risk but attractive investments for our pension funds.

(1,171 words)

November18th, 2022

For:Firstpost/News18.com

Gautam Mukherjee