Given the drawbacks of the traditional provisions for pensions, India faced pressures for reform, which led a decade ago to two separate developments. The first of these was the OASIS report initiated by the Ministry of Social Justice in July 1998, written by a Committee chaired by Surendra A. Dave, a former Chairman of the Securities and Exchange Board of India (SEBI), with Gautam Bhardwaj of Invest India Economic Foundation serving as the Member-Secretary of the Committee. The OASIS report essentially put in place a framework for setting up DC pension provisions for the informal sector. The second development was a report undertaken independently of the OASIS project in October 1999 by the Ministry of Finance, on the reform of the Civil Service pension provisions.
Vested interests can always become entrenched within any bureaucracy, and India is notorious for its byzantine complexity. As Gautam Bhardwaj, one of the architects of the reform process says: “India needs to adopt a holistic approach to the provision of pension provisions for the poorest segments of society. The problem now is that responsibility is split between a number of Ministries, making it difficult to bring about the changes that are needed.”
What are the changes that should be the ideal? Shah outlines them as the following, all of which are incorporated in the National Pension Scheme and outlined in the original Oasis report:
1. Coverage: Pension provisions need to address the 85% of the 400 million workforce that does not have any access to a formal pension scheme.
2. Sustainability: Shah points out that India has had many instances of failures of guaranteed return savings schemes, such as the EPS and the assured-return products sold by UTI, which led to the central government having to intervene. A long term sustainable scheme must be based on a solid foundation of defined contributions, where the wealth of a participant is led purely by net asset value. It should avoid assured returns, subsidies, guarantees or liabilities for the central and state governments.
Moreover, Shah sees that: “A goal of pension reforms should be to separate government from the process, if making monthly pension payments to citizens, over and beyond the monthly contributions paid into the pension accounts of government employees participating in a DC system.”
3. Scalability: The architecture of the pension schemes need to be suitable for Central, State and Local governments as well as the hundreds of millions of workers in the uncovered informal sector.
4. Outreach: The institutions and policies need to be designed to cater for the needs of a large mass of participants who are expected to be financially unsophisticated, who are presently not covered by financial services, engage in small value transactions and have small sums available for pension provisions.
5. Fairplay and low cost: The architecture should ensure the highest levels of transparency, competition and sound policy making.
6. Choice: The design has to be highly transparent, and give participants the choice between multiple competing pension fund managers, investment styles and competing annuity providers.
7. Sound regulation: There needs to be a regulatory framework focused in maximising the welfare of participants in old age.
The Civil Service report recommended a hybrid DC/DB pension provision for public sector workers. But as Dhirendra Swarup, the Chairman of the Pension Fund Regulatory and Development Authority (PFRDA) pointed out at the IIEF conference, civil service pension obligations were increasing at a compounded rate of 21% p.a.. The Central and State governments were paying out 70,000 crore of rupees ($15bn) out of their budgets for pensions, which in 10 years, would have meant that 50% of their total budgets would have been spent on pensions and salaries of their own employees. Not surprisingly perhaps, in the light of these statistics, the Indian Government did not accept the recommendations to continue with an element of DB provisions and ruled that Civil Service pensions would move onto a DC basis from January 2004, following the framework set out in the OASIS report.
The PFRDA bill was initially introduced in March 2005, and had the objective of setting in place a purely voluntary DC pension scheme (the New Pension Scheme or “NPS”) that could be utilised by both the informal and as it turned out, the formal sectors as well. Whilst it may be thought that the creation of a voluntary pension scheme should not be a controversial issue, the bill did arouse some political opposition and as Swarup explains, it languished in government for 4 years, and will now be reintroduced in the coming session.
Despite the lack of formal legislation, the essential architecture was allowed to be put into place through contractual arrangements, with the creation of the PFRDA, and the framework installed for the provision of mass DC pension provisions in the National Pension Scheme (NPS). External fund managers in the form of SBI, UTI and 4 others have been selected for the Civil Service scheme, along with a custodian and other operational requirements finalized.
As of November 2009, there were 700,000 subscribers to the NPS, with 22 of the 28 State Governments agreeing to move onto scheme. However, as Swarup points out, it still took more than 4 years for the civil service to transfer funds to the NPS to be managed by professional fund managers.
The NPS was extended to all citizens on a voluntary basis in the first half of 2009. So far, the results can only be said to be disappointing in terms of attracting individual participants, with just 3000 as of November 2009. But Swarup declares that critics need to be patient. The education process is just beginning. As he pointed out, there are a number of reasons for the low take-up so far which include:
1. A lack of preparedness from the points of sale for pensions. In future, the PFRDA intends to monitor the performance of sales channels against their submitted business plans.
2. The lack of awareness of the products on offer. The PFRDA will be leading an awareness campaign.
3. The competition from the insurance and mutual fund industries. Swarup’s view is that there is not currently a level playing field for the different providers of savings products.
4. The tax system currently places the NPS at a disadvantage vis a vis insurance products. Swarup sees the new tax regime as providing an incentive.
5. More fundamentally, the NPS was designed with a view to keeping intermediary costs at a minimum. As a result, the PFRDA has adopted a direct sales model, without any sales force. This avoids any danger of mis-selling and also radically cuts down the transaction costs. However, it does mean that alternative approaches need to be devised to educate and reach out to potential participants.
Swarup sees the advantages of the NPS over other savings and pension products as the following: A unique record for each individual and hence portability across employers; flexibility across investment classes; flexibility across fund managers; and very low transaction costs with no front end fees paid out to intermediaries. Ultimately, the success of the NPS will be based on the returns that are delivered to the participants. So far, the trend has been good, with Swarup indicating a return of 14% in the first year of provision for the NPS against the 8% delivered by the government scheme.
The NPS is clearly at a very early stage in its development, and the critical issue is how it can be rolled out on a voluntary basis to literally hundreds of millions of workers who have had no exposure to financial services. This issue will be a huge challenge for many years to come. Enthusing workers on saving for their pensions when they have little or no exposure to financial products and may be based in remote locations far from any bank is a non-trivial problem. - But it is the key to the eventual success of the NPS and the alleviation of old age poverty in India. The progress and ideas discussed at the IIEF Pension Policy Conference suggests that there is a way forward, albeit with many obstacles in the way.