India is grappling with the complex issues surrounding the development of a pension strategy that can address the issues of the majority of the population, as well as the minority who are in formal employment in the public and private sectors. In this special report, IPA’s India correspondent Joseph Mariathasan explains the issues and talks to those involved in mapping out India’s pension future.

Fully 85% of the 450 million workforce does not have any access to a formal pension scheme, relying on their children who themselves may be too poor to carry the burden of aging parents.

The last few years have seen enormous progress in developing the framework for an all-encompassing strategy. The next few years will hopefully see many of the initiatives translated into actual pension provisions for tens, and possibly hundreds of millions, of the poorest segments of India’s population. There is much to be positive about; India has a huge demographic advantage over most countries, in that the average age of its population is only 26 years. But as the proceedings of the 9th Invest India Economic Foundation (IIEF) Pension Policy Conference held in New Delhi in November, showed, there are still many hurdles to be overcome for the vision of adequate pensions for all to be achievable.


India does not have a comprehensive population-wide old age income security system. The vast majority of the population relies on support from their children in old age. As Ajay Shah, a Senior Fellow at the National Institute of Public Finance and Policy explains, prior to the reform process put in place in recent years, there were two narrow schemes available for pension provision. First of all, the civil servants’ defined benefit pension which covered 26 million workers, and the second was the ‘organized sector’ system which was encompassed by the Employees Provident Fund Organisation (EPFO) which covers around 15 million workers.

The traditional civil service pension was indexed to wages and as a result, the growth in pension benefits was typically higher than inflation. Shah’s analysis showed that over a 14 year period to 2004, whilst nominal GDP grew by a compound rate of 14.3%, central government pensions grew at 16.37% and state government pensions at 19.6%. The combined outgoings as a percentage of GDP went from 1.46% to 2.31%.

As Shah points out, the scheme was designed in a world where most workers who retired at 60 were dead by 70. But the value of the embedded annuities have gone up dramatically as a result of increasing longevity, particularly for the upper echelons of government employees who now have mortality characteristics comparable to those of OECD populations. Moreover, Shah also points out that some public sector companies have DB pension funds that are likely to be underfunded. Their liabilities could cascade up to the central government exchequer at a future date, with no public data even available to assess the issue.

The EPFO has two main schemes, the “employee provident fund (EPF) and “the employee pension scheme” (EPS), which apply to firms with over 20 employees in defined industries. All activities required are undertaken by EPFO itself except for fund management which is outsourced to one external agency such as the State Bank of India.

Firms covered under the EPF can seek exemption for fund management and set up their own self administered funds. These “exempt funds” have to at least match the investment returns of the EPFO. 

Whilst EPFO data indicates the presence of around 40 million members, Shah points out that many of these are dormant accounts which come through administrative difficulties in shifting an account from one employer to another. Independent estimates suggest a figure closer to 15 million members in late 2004. As Surendra Dave, the ex-Chairman of the Securities and Exchange Board (SEBI) pointed out in a 2006 paper, the EPFO was created in 1952, when there was very little understanding of pension economics: “A major role in the governance of EPFO was given to trade unions. These origins, and the governance structure, have been the root cause of a series of policy mistakes.”

The EPF is an individual account defined contribution scheme based on a contribution rate of 16%. But as Shah points out, workers tend to retire with very small balances in the EPF. “In 2002-03, the mean pension wealth that came into the hands of a newly retired person was merely Rs.36,000. If this money was used to buy an annuity from LIC (Life Insurance Company of India), it would yield a pension of Rs.230 per month, or 9% of per capita GDP.”

The EPS is a DB system based on a contribution rate of 8.33% with the government contributing an additional 1.16%. It was created in 1995 applying only to workers who started work after that date. It provides a defined benefit at a rate of 1/70 of the last 12 months earnings prior to retirement, for each year of service, subject to a maximum of 50%.

The EPFO has admirable objectives, but it has so far failed completely to deliver adequate pensions, despite the sums individuals put into it over their working lives. For employers, the EPF represents essentially a tax their employees have to pay out which would not be forced upon them in the informal sector. As a result, formal sector employers can struggle to compete with the informal sector, according to Manish Sabharwal, the Chairman and co-founder of Teamlease Services, India’s largest temporary staffing firm. Around 95% of job creation is now in the informal sector he argued, and they do not deduct from wages to pay benefits, as with the EPF.

Moreover, he pointed out that the EPF seems to charge over 4% in fees to just invest in government securities. Yet even here, as Shah says, just one years contribution of Rs. 2,500 at age 20 can yield a pension pot of Rs. 25,000 at age 60 in a properly designed pension system. The failure of the EPFO schemes to provide adequate retirement income Shah attributes to administrative difficulties when accounts get closed or lost over job changes and also provisions for premature withdrawal of balances. There were also concerns over the funding status of the defined benefit EPS fund, which did not change contribution rates at all despite a dramatic change in bond yields from 13.4% in January 1997 to 5.1% in October 2003.

The EPFO has also been criticised strongly by many, including Shah, for being burdened with a complex mandate that encompasses record keeping, administration, supervision and regulation. Shah sees this as inconsistent with modern institutional architecture, where unbundling is favoured in the interests of transparency and competition, whilst regulatory functions are kept distinct from service provisions.

Perhaps one of the most pernicious aspects of both the civil service scheme and the EPFO is that the fiscal transfers are disproportionately captured by the rich. The EPF gains an explicit subsidy in the form of special deposits which are deposited with the government at above market rates of return. Shah points out that amongst EPF customers, as much as 83% of the assets are controlled by 15% of the accounts so that the bulk of the subsidy is being captured by the richest amongst them.

The defined benefit civil service scheme and the EPS also generate very different payouts for people in different income classes. As poorer people are likely to die sooner, the benefits obtained by the longer-lived wealthier individuals are much higher than those obtained by the poorer members if the scheme, which are thereby implicitly subsidizing their richer brethren!