sAll the state governments in India have decided to exit the National Pension Scheme for their employees and go back to the old pension scheme. They see this as a move to protect the old age income security of their employees. However, the reality is that they are postponing the current financial strain on finances for the foreseeable future, thereby increasing the pension risk of the employees.
two pension plans
Until 2004, government employees enjoyed a ‘defined benefit (DB) pension’, which meant that upon retirement, they would receive a pension equal to about 50 per cent of their final pay for the rest of their lives. And who paid for it? Ultimately the taxpayer.
By the early 2000s, the fiscal deficits of the central and state governments began to increase. Policy makers began to worry that such pensions would not be sustainable and would run out of money with the states. At that time the Atal Bihari Vajpayee government came up with a ‘Defined Contribution (DC) Scheme’ – NPS. Under this scheme, the contribution is taken by the Central Government and the employee, and on retirement, the employee can take a part of the accumulation as a lump sum and the other as an annuity (pension). By contributing upfront, the government will reduce its un-financed pension liability in future.
The central government implemented NPS only for those who joined the service from January 2004. The state governments adopted the same system for their employees. But this year many state governments want to bring back the old DB scheme.
double payment problem
Contributory system like NPS is a check against the future liabilities of the governments. However, at present, the state government is paying for both sets of employees – there is a pension bill for retirees and a contribution bill for employees. From a fiscal point of view, the benefit of NPS will be visible only when the existing employees start retiring. He is still two decades away.
as a fiscal place With the number of states weak, reversing the NPS appears tempting. States believe that they can save money by giving up on NPS and deal with the pension problem when this happens. Indian states are not unique in getting cold feet as the transition from DB to DC continues. Reforms have also been reversed in many countries of Eastern Europe because theydouble payment problem, But by postponing the problem for future, the state governments are increasing the risk of DB pension for their employees.
Risks of DB Pension
A DB scheme that guarantees a pension equal to 50 per cent of the last salary and is indexed for inflation is an attractive proposition. But there are two flaws in Kavach that government employees need to think about more carefully.
A DB plan makes promises after 50 years. A lot can happen in this time – people may live longer than expected or macroeconomic conditions may change such that those payments are no longer viable. Worldwide, dB Schemes are struggling to deliver on their promises and need additional funds, As workers progress into old age, state fiscal finances may deteriorate and governments may find it difficult to keep promises. delayed pension payment Not uncommon in India. And while the Supreme Court has ruled that Interest to be paid in case of delayFighting for your rights in old age can be difficult.
Second, governments can and do reneged on their promises through fraudulent means. Croatia and Belgium stopped increasing past earnings, entering a profit formula corresponding to an average wage increase. Austria and Greece reduced the accrual rate, which reduced the initial pension. Italy, Sweden, Latvia, Poland and Norway have moved their public employment-related schemes to an actuarial method of calculating benefits and eliminated all internal redistribution.
The retirement age has increased steadily in almost all OECD (Organization for Economic and Co-operation Development) countries. In fact, future life expectancy is included in the pension benefit formula in all Nordic countries. Such other adjustments, or wage increases, to the benefit formula are a core element of pension policy around the world. in India, Growth Due to One Rank One Pension (OROP) policy, there is one in DB Pension for Armed Forces. key driver With Agneepath Scheme it would be short-sighted to expect that Indian civil servants will somehow be protected from the pressures that come with continuance of DB pension.
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Government guarantee is not permanent
Most employees think in binaries – that which is market-linked is risky, and that which is guaranteed by the government is safe. There is a firm belief that the government will never be short of funds, and that even if it goes through a period of fiscal stress, it will cut spending on other things but continue to pay pensions on time. Past experience shows us that guarantees are not as sure as they seem. There are risks with DB Pension as well, and these are more opaque than market risks.
NPS market creates risk. but as we have arguedMany problems of NPS can be easily solved. It is possible that the NPS annuity will be less than 50 per cent of the promised final salary of the DB scheme. But there is no risk that the benefit formula will change, or that a government with no financial pressure will not give pension on time.
Leaving the NPS would be a tragedy. States have already come half way to reduce pension liabilities. In the next 20 years, NPS groups will start retiring and the benefits of the reform will start showing.
The author is Associate Professor at the National Institute of Public Finance and Policy (NIPFP). She tweets @resanering. Thoughts are personal.
(Edited by Likes)