Gautam Bhardwaj: Provide pensions for low-income families

Organisations such as SEWA and COMPFED have successfully experimented with micro-pension schemes for members.

An important social objective for the central and state governments is to provide opportunities for the low income unorganised sector workforce, who traditionally have been excluded from formal pension schemes (and from the pensions debate), to build up savings for retirement in a well regulated environment.

In this context, the January 22 meeting between the central and state governments is an important milestone in India's pension reform. It clearly demonstrated that the Indian government is today more committed than ever about taking the PFRDA Bill to conclusion. It also signalled that at least 19 of the more progressive states are now getting very impatient with the delay at the Centre. But most importantly, it broadbased the debate by highlighting the social imperatives of pension reforms and the potential cost of inaction.

For some time now, it has been amply evident that the NPS design is well geared to serve the millions of civil servants and unorganised sector workers who have the capacity to save for their own retirement. With low service delivery costs, nationwide access and professional funds management, it has been assumed also that the PFRDA and the NPS architecture will deliver the required regulatory and administrative capacity to service the retirement savings needs of millions of low income workers. However, access, high returns and regulatory focus are only a part of a full old age income security solution for this population. Left to themselves, a majority of low income workers will not derive adequate retirement outcomes even if they save a significant part of their incomes over multiple decades.

For this population therefore, the central and state governments should consider a system of co-contributions towards old age income security. In addition to being a significant step towards financial inclusion, this will provide a tangible incentive for low income workers to undertake voluntary retirement savings over multiple decades. It will supplement the savings of these groups so that when they reach their retirement years, the value of their savings provides a better buffer for protecting them from poverty.

Apart from the obvious social policy attractions of this approach, there is an important vertical tax equity issue involved as higher income earners enjoy the benefit of up to Rs 30,000 tax deduction for pension contributions under Section 80C. For poor workers, a pension co-contribution recognises that such tax benefits are not available to them.

Delivering a targeted co-contributions based old age income security arrangement for low income groups, however, requires that some form of means testing, along with an appropriate administrative mechanism, is put in place in order to confine the benefits to the intended target audience. However, administering broadly based means tests in India is not a practical option at this time as there are no reliable and comprehensive data that are collected regularly on the individual incomes of potential target populations.

In this context, central and state governments can effectively target workers associated with self-help groups (SHGs), micro-finance institutions (MFIs) and cooperatives for delivering a targeted means-tested pension co-contribution arrangement. These agencies can administer an effective proxy means test for pension co-contributions targeting purposes based on their local knowledge of their members' actual incomes.

These agencies are also well placed to act as a port for collecting modest pension contributions from members and pooling and transferring them for onward investment to fund managers appointed by the PFRDA. It is, therefore, feasible to base the administration of a co-contributions arrangement on these capabilities and target low-income social security contributors who are members of such associations.

To test the capability of MFIs and cooperatives in delivering a social security arrangement to their members as well as to assess the level of demand and capacity for voluntary retirement savings by the lowest income workforce, SEWA introduced a new Defined Contribution (DC) micro-pension scheme based on individual retirement accounts for its members in collaboration with UTI AMC. This scheme was launched by the finance minister at Ahmedabad in April 2006. Coverage of this scheme already extends to over 30,000 low income women and is expected to rise to 50,000 members by March 2007. This pilot scheme was also offered by UTI to members of COMPFED, a milk cooperative in Bihar, and attracted around 50,000 members within a few weeks of its launch by Bihar's chief minister in September 2006.

Under this scheme, SEWA and COMPFED collect individual monthly contributions and transfer a pooled sum, along with an electronic statement of names, individual account numbers and corresponding contributions by each member in a single transaction to UTI. These savings are invested by UTI and earn market-linked returns. It is not surprising that a number of MFIs, associations and cooperatives from several states (including Tamil Nadu, Assam, West Bengal, Karnataka, Madhya Pradesh, Orissa, Kerala, Punjab, Maharashtra, Uttar Pradesh, Rajasthan and Andhra Pradesh) are now stepping forward to offer a similar contributory pension scheme.

The challenge of achieving voluntary coverage of a contributory pension scheme across states, therefore, is not a dormant demand. The issue is how to awaken that demand from an audience that has little knowledge of, or discipline with, formal financial savings and saving for retirement.

Such a pension co-contribution scheme that targets members of MFIs and cooperatives is unlikely to cost either the centre or individual state governments too much. For one, penetration of the potential target group by the institutions concerned is only a small percentage of the total unorganised sector population. Also the incomes of the target group are very modest and the cost of a co-contribution will be similarly modest.

Taking these factors together, it is possible to come up with rough estimates of the probable costs to the government of establishing a co-contribution scheme. For example, if a matching social security co-contribution of upto 100 per cent of monthly savings (subject perhaps to a co-contribution ceiling of Rs 100 per member per month) were put in place for all members of (say) micro-finance institutions in the country, and if there was a very high take-up of the arrangement (say 60 per cent of all micro-finance members contributed an average of 10 per cent of income) the annual cost to all state governments put together, of such a co-contribution would not exceed Rs 200 crore. This amount is modest compared to the additional budget allocation of Rs 1,430 crore made by the central government for 2006-07 for the National Old Age Pension Scheme.

The author heads Invest India Economic Foundation, a pension-policy think-tank