Reform reversal

States should not go back on pensions

There is a wide consensus among experts that India needs to take the economic reforms process forward to attain higher sustainable growth, which is essential to create jobs and pull people out of poverty. One of the important aspects of the overall process is the way the government manages its finances. It is important for higher growth and financial stability that government finances are well managed. Over the last couple of decades, both the central and state governments moved broadly in this direction. However, signs of a dangerous reversal are beginning to emerge. Although budget deficits have increased because of the pandemic, political parties and governments are committing to expenditure that can have longer-term adverse consequences. One big example in this context is the recent reversal of pension reforms by the Congress party-led Rajasthan and Chhattisgarh governments.

Both governments have gone back to the old pension scheme. The Union government had moved to the new pension system with a defined contribution in 2004. Barring a few exceptions, state governments also joined. Now, two state governments have decided to go back to the old system. It is reasonable to assume that such demands will be raised in other states as well and governments would be prone to accepting them to retain popular support. This would be a reversal of a hard-won reform with serious long-term fiscal consequences. Economists at the State Bank of India have highlighted what this could mean for government finances. The old system is essentially unfunded and is paid by current revenue. According to estimates, the pension liability of state governments over the past 12 years ending fiscal year 2021-22 (FY22) has grown at a compound annual growth rate of 34 per cent. The pension outgo in FY21 was at about 30 per cent of states’ own tax revenue and 13.2 per cent of overall revenue receipts.

These numbers give a broad idea of the state of affairs. The pension outgo for state governments at the aggregate level is worth about 1.9 per cent of gross domestic product (GDP) and would continue to increase. It is worth noting that India’s demography is changing rapidly with increasing life expectancy. The pension bill, therefore, will continue to rise and affect the state government’s ability to spend on other critical areas. The committed expenditure of states at the aggregate level is higher than their own revenue. With the reversal of pension reforms and an increase in other populist spending, the situation will only worsen. The Reserve Bank of India, for instance, in its annual study of state government finances, has been highlighting the deteriorating quality of expenditure in recent years. With additional committed expenditure, state governments will find it difficult to spend on building productive capacity.

It is now fairly clear that the government will have to do the heavy lifting in building infrastructure as private capital is not very keen on this area because of a variety of reasons. Since states account for a higher share of general government spending, health of their balance sheet is more important for growth and development. At a more broader level, it is necessary to arrest this trend of increasing political populism. India needs a strong political consensus on basic economic issues and the central government is in the best position to initiate this process.