NPS before PFRDA

Nineteen states have now adopted the New Pension System (NPS). They have followed the central government's strategy, of picking a cut-off date and placing all new recruits after this cut-off date into the NPS. Put together, a substantial number of civil servants are now part of the NPS. The unfortunate situation is that while a 20 per cent deduction is being done every month, the record-keeping is not being done properly, employees are not getting account balance statements, and the money is not being invested properly. It is now three years since the cut-off date of January 1, 2004, and the government is increasingly doing damage to the lifetime pension planning of these individuals. As an example, these employees have lost an opportunity to participate in the 200 per cent rise in the stock market.

The ministry of finance appears to be ready now to take on the problem of establishing the mechanisms for record-keeping and fund management, which must not be under-estimated. In Poland, for example, the old government agency (the equivalent of the EPFO) was put in charge of record-keeping for the new "defined contribution" system and there were wrangles for over a decade owing to mistakes and lost records. There is a challenge in capturing data from all across the country""for central and state government employees""and ensuring a monthly contribution flow. The simplest strategy would be to mimic what is done by many countries, to merge the pension payment flows with the income tax payment flows, for both these are pay-roll deductions.

The government now appears likely to achieve passage of the PFRDA Bill, with some changes. The exact nature of these changes is not yet known. Many analysts might applaud the progress of Indian pension reform. However, the pitfalls of the coming weeks must not be under-estimated. The field of pension economics is littered with disastrous mistakes in policy design. Apparently insignificant and small changes to the pension system design, which will be almost unnoticed in 2007, can turn into problems worth 10 per cent or 20 per cent of GDP by 2027. The analysis of pension systems is subtle, and the process of political compromise repeatedly comes up with wrong outcomes. As an example, the Employee Pension Scheme (EPS) was pushed through by the trade unions in 1995 with tall promises and poor analysis. It is now understood to be a severely under-funded scheme, which has managed to place large liabilities upon the exchequer. Similarly, the Arjun Sengupta proposals appear to be politically attractive, but may be quite imprudent.

The key benefit of "defined contribution" pensions is that they de-politicise the subject, by shifting to a "net asset value" (NAV) system. The role of the government becomes that of setting up institutional mechanisms; every employer chooses the contribution rate; participants engage in lifetime financial planning. The Left has been insisting that there should be "defined benefits". If the government gives in to this demand, it would fundamentally subvert the economic benefits of the NPS, and constitute a historic mistake. It would be better to progress on the implementation of the NPS and to not enact flawed legislation. Once the NPS is on a sound footing, the PFRDA Bill can be taken up after the next general elections, when the Left parties may not command a veto power over all such legislation.