Save NPS from being pensioned off

If governments revert to the OPS, it will immediately stop the employer's contribution to the NPS, but the chickens will come home to roost only in the late 2030s.

In her Union Budget Speech, Finance Minister Nirmala Sitharaman explicitly expressed her hope that the committee set up to restructure the new national pension scheme (NPS) will meet employee expectations while respecting fiscal prudence. The concern may be due to impending elections in a few bellwether states.

The reversion to the Old Pension Scheme (OPS) waxes and wanes with electoral fortunes — round one in the state polls of Punjab, Karnataka, and Himachal Pradesh went to the Opposition. The Congress dropped it from its manifesto during the general elections, ostensibly awaiting the committee's report. It is very likely to stage a comeback in the state polls in Maharashtra and Haryana, and the concern is that the baby should not be thrown out with the bathwater. In the state elections, government employees form a powerful bloc and the NPS is probably their most important issue.

The origin of the NPS was in the turbulent 2000s. There was a realisation that the government's wage and pension bills were growing at the expense of other developmental priorities. The pay commissions were very generous, and the VI Pay Commission was the most gracious. It raised the wage and pension bill to the stratosphere, leading to a cascading effect on state governments that could ill-afford such generosity.

The high wage and pension bills led to reforming the pension system of government employees from the Defined Benefits Pension (DBP) to the Defined Contribution Pension (DCP), from 2004, in line with the rest of the formal sector. A new structure was designed with a pension regulator and asset managers, and it has a bouquet of choices for varying risk appetites. This also helped channel private savings into capital formation, thus aiding growth. Almost all states, except West Bengal, also accepted the NPS. This reform where good economics triumphed over politics was significant, given the heterogeneity of ruling parties in various states.

In parallel with these developments, the government did not implement the accrual accounting despite agreeing with the XII Finance Commission's recommendation. The existing cash accounting system simply accounts for the cash outgo and the reduction of the government's future liability does not show up in its books. Therefore, the pension reform, though bold and pathbreaking, did not show up in its books, and brought little benefit to the governments struggling for fiscal space.

From 2004 onwards, the NPS created two groups of government employees who had to co-exist for a long time, as the government employees under the Old Pension Scheme (OPS) would retire only in the mid-to-late 2030s. It worsened the fiscal position in the interim, as governments had to pay pensions to existing OPS retirees, and make employer contributions to the NPS employees.

The benefits to the governments will kick in all at once when the OPS pensions trickle to a stop sometime in the late 2030s. By that time, existing employees who enjoy pensions would have retired, and the annual payout of capitalised pension benefits to new retirees under OPS would not be required. The OPS number will also reduce. The government would only need to meet the employee contribution of about 14% of pay for the NPS for the employees who joined after 2004. This will shave around 3% of the GDP from its expenditure.

However, if governments revert to the OPS now, it will stop the employer's contribution to the NPS immediately, and the chickens will only come home to roost after the 2030s. Ah, the long run! But then, who is bothered about the long run; as John Maynard Keynes famously stated, “In the long run, we are all dead”. The move to revert to the OPS is immensely popular with government servants, a constituency that is politically very salient and electorally very useful. Hence, five states recently succumbed and slid back from a hard-won consensus. 

The newly recruited employees are very unhappy at being denied a fixed benefit. The problem was exacerbated by the poor design of the NPS, without considering the Indian context. The NPS also saw the global meltdown around 2008-2010, followed by the Covid-19 crisis a decade later, but the favourable market conditions were not fully exploited. For instance, the Government of Tamil Nadu has the corpus parked in LIC debt, instead of the equity market, with very poor returns.

The employees transitioning to a defined contribution scheme are not equipped to choose individual models for investment based on risk appetite, considering the information asymmetry. The individual accounts also lead to problems of timing the market as their retirement may coincide with a crisis like Covid-19, where their corpus valuation will be very low. I am still to understand what the driver was behind this model. While private sector employees have a pooled vehicle in the Employees’ Provident Fund Organisation (EPFO) for their defined contribution pension fund, the NPS increasingly looks like a scheme designed for the fund managers, by the fund managers. 

It is imperative that the government restructure the NPS as a pooled vehicle and build reserves during favourable market conditions to guarantee a secure future for all government employees. Restructuring the NPS is the key, not reverting to a Defined Benefit Scheme funded by the exchequer.

(Kesavan Srinivasan is senior adviser, Janaagraha, and former deputy comptroller and auditor general.)

Disclaimer: The views expressed here are the author's own. They do not necessarily reflect the views of DH.