Pension benefits

A big step forward for the financial sector

The long overdue passage of the Pension Fund Regulatory and Development Authority (PFRDA) Act by Parliament last week marks a significant move forward in the process of financial sector development. The Act gives statutory powers to regulate pension products as well as the fledgling New Pension Scheme. It provides for 26 per cent foreign direct investment in pension fund managers, though it has benchmarked this to the ceiling applicable to insurance companies. Importantly, it enables the provision of pension schemes with different risk profiles; clients can now choose between portfolios consisting entirely of government securities and those incorporating a fair proportion of equities. All these factors presage steady growth in the volume of funds managed by pension funds and, alongside this, the development of a range of products that will serve two purposes. One, they will give savers better returns over long periods of time, enabling them to maintain living standards after they retire. Two, they will create a powerful new channel of investment into long-term assets, including infrastructure, which will go hand in hand with a pressure on managements to create and preserve value. All in all, the record of pension funds in countries in which they are significant players has been very positive on both these benchmarks.

Yet, given the structure of India's workforce - barely about eight per cent in the organised sector and a very large number in seasonally driven agricultural activity - the natural question is: how many people can actually benefit from this initiative? Will volumes reach levels that make innovation and product differentiation feasible? These are legitimate questions, but such concerns should not derail the progress on this front, however discouraging early results may be. An important reform measure in this regard is to move the entire existing provident fund corpus into a pension fund mode. All current account holders must now be given the choice of both managers (when they set up shop) and, critically, risk profiles. The government, whose employees are the largest contributors in the aggregate, but which also benefits from the captive investment of these funds into its securities, will obviously resist the potential competition for resources. But it must not do anything to undermine the growth of the sector.

On the other side of the equation, every effort must be made to ensure that these funds are investing in a conducive environment. Particularly with respect to infrastructure, the enormous policy, regulatory and operating uncertainties facing many projects are hardly going to encourage prudent pension fund managers. The more these projects inspire confidence, the more effectively pension funds can deliver on their promise to finance these long-term assets. The very long horizons that the country's demographic profile implies actually provide a huge opportunity for investment in such assets, which should be exploited as quickly and as much as possible. Finally, pension funds are not going to be subscribed to automatically. The concept has to be effectively marketed and sold. Cheesy television commercials will not do it; a systematic campaign to reach out to young workers and college students needs to be initiated as well.