In a landscape where financial security and retirement planning are integral facets of a stable workforce, the recent decisions by the governments of Rajasthan, Chhattisgarh, Jharkhand, Punjab, and Himachal Pradesh have sent ripples through the corridors of public service. These states have opted to navigate a course back to the Old Pension Scheme (OPS) for their state government employees, steering away from the newer pension models that had been set in motion.
The recent communication from the finance ministry, confirming these states’ requests for the withdrawal and refund of pension contributions, along with accrued returns, has catapulted this matter into the spotlight. It’s a move that raises a myriad of crucial questions, particularly regarding the financial well-being and plans of the state employees affected by this shift.
RBI’s statement
According to a statement by the Reserve Bank of India (RBI), internal assessments suggest a substantial fiscal burden if all state governments transition back to the Old Pension Scheme (OPS) from the National Pension System (NPS). The RBI report projects this shift could amplify the fiscal load to an estimated 4.5 times that of the NPS, translating to an additional burden equating to 0.9 per cent of the GDP annually by the year 2060.
Highlighting the potential implications, the report underscores that this reversion will significantly impact the pension responsibilities, particularly for older OPS retirees, expected to draw pension benefits until the 2060s. This projected timeline extends beyond the retirement period of the last batch of OPS beneficiaries, expected by the early 2040s.
The RBI report expressed concern, characterizing any shift back to OPS by the states as a substantial regression. Such a move, it cautioned, would counteract the advantages gained from prior reforms and jeopardize the interests of future generations, hinting at the sustainability challenges such a decision could pose.
Moreover, the report brings attention to the fiscal deficits of certain states, noting that some have budgeted for deficits exceeding 4 per cent of Gross State Domestic Product (GSDP) in the fiscal year 2023-24, compared to the national average of 2.76 per cent. This observation emphasizes the varied fiscal capacities and potential strain on state finances that a reversion to OPS could intensify.
The report cautioned that any additional provisioning of non-merit goods, services, subsidies, transfers, or guarantees could significantly destabilize the fiscal landscape for the states. This, it warned, might disrupt the commendable fiscal consolidation achieved over the past two years.
Highlighting the positive strides made in state finances, the report noted that the progress observed in the fiscal year 2021-22 was sustained throughout 2022-23. Notably, the collective gross fiscal deficit (GFD) of the states remained contained at 2.8 per cent of the gross domestic product (GDP) for the second consecutive year, surpassing the budget estimates. This accomplishment primarily stemmed from a reduction in the revenue deficit.
Source: businessline.com
Reasons for the introduction of National Pension System (NPS)
•Limited Coverage of the Old Pension Scheme(OPS)– OPS exclusively catered to government employees, constituting approximately 12% of the nation’s workforce. The National Pension Scheme aimed to extend pension benefits to workers in the unorganized sector, allowing them to enrol in the program voluntarily.
•Huge Fiscal burden on the Central and State Governments due to OPS– With every new pay commission award, the basic salaries of the Government servants were increasing. This was increasing the burden on the Union and state exchequers in making pension payments under the OPS scheme. According to the India Pension Research Foundation, the expenditure on Union civil service pensions was around 2.31% of the GDP in 2004-05 and the implicit pension debt of the Government of India was around 56% of the GDP.
•Burden on the future Generation due to OPS– Under the OPS Scheme contributions of the current generation of workers were explicitly used to pay the pensions of pensioners. Hence OPS scheme involved the direct transfer of resources from the current generation of taxpayers to fund the pensioners.
•Disincentivised Early Retirement– The OPS scheme was used to disincentive early retirement as the pension was fixed at 50% of the last drawn salary. Hence even the disinterested govt employees used to linger around to reach their retirement age to avail maximum pension. This resulted in massive underutilization of human resources.
•Flexibility– NPS allows the subscriber to choose the fund manager and the preferred investment option including a 100% government bond option. A guaranteed return option could also be considered to provide an assured annuity.
•Simplicity and portability– Opening of account with NPS provides a Permanent Retirement Account Number (PRAN) which remains valid throughout the lifetime of the subscriber. The NPS is also portable across jobs as the PRAN account remains the same.
•Well Regulated Scheme– An NPS Trust has also been constituted to regularly oversee the performance of fund managers with a trustee bank to efficiently manage fund flows. A custodian has also been appointed to hold the securities with subscribers being beneficial owners of the assets.
Issues with National Pension System(NPS)
Market Volatility/Uncertainty– Contributions under the NPS scheme are invested in the markets through the fund managers. There is an apprehension that the new NPS will not deliver the same benefits as the old scheme. The returns will be impacted by market volatility and uncertainty. As per the SBI report, NPS asset growth has been affected by the Ukraine-Russia conflict and may fall short of the declared target of Rs 7.5 lakh crore by March 2022.
Increased burden on Employees– Under the old pension scheme all the burden of pension was borne by the government. There was no requirement for monthly contributions from employees in the pension fund. Hence the employees used to get greater disposable monthly income in their hands and an assurity of pension. NPS has decreased the disposable monthly income in the employees’ hands by 10% of their basic pay and DA is deducted every month.
No General Provident Fund (GPF) benefits– Under the Old Pension Scheme (OPS), fixed returns were guaranteed for employee contribution to the General Provident Fund (GPF). However, NPS has no General Provident Fund (GPF) provisions.
Reasons for Shifting to OPS
•Political Gains- The OPS scheme has been politicised to gain a vote bank by the political parties. Government employees are a very vocal and important pressure group and Vote Bank.
•Deferment of matching Govt contribution– The Government when they switch to OPS defer the payment of a matching 10% contribution towards NPS by a few years. This however is a very short respite for the government as they have to end up paying much more after a few years when the employees under NPS start retiring.
Concerns raised against the re-implementation of OPS
RBI, NITI Aayog, and Finance Commissions have raised serious concerns about reintroducing OPS:
•Funding Challenges: There’s no designated fund to support OPS pensions. Clear funding mechanisms or sources to sustain pension payouts are lacking.
•Sustainability Issues: OPS faces sustainability problems as pension liabilities grow annually due to rising dearness allowances and longer life expectancies.
•State Financial Strain: State governments are spending a significant portion of their revenue, about a quarter, solely on pensions. Reverting to OPS could escalate state debts further.
•Taxpayer Burden: Taxpayers are already bearing the load of funding OPS pensions and contributing to NPS for new employees. Reverting to OPS will heighten the burden on taxpayers.
What Should be the way ahead?
Various economists have suggested several ways out which are being scrutinised by the TV Somanathan committee. Some of the ways ahead can be as follows-
Designing an “Assured Pension Scheme”– Some states have suggested designing an “assured pension scheme” by linking it to the minimum level of pay and not the last drawn salary as provided under OPS.
Combining the OPS and NPS scheme- The new pension framework can be designed by taking “defined contribution” by employees element of NPS and “defined benefits” of the OPS.
Role of future pay commissions- The future pay commissions should move towards the concept of “cost to company” (C-to-C) and include the cost of assured pension while determining pay revisions.
Restructuring the civil services- The government should also revisit the structure of the civil services to ensure that the organizations don’t become ‘top heavy’ as it would increase the pension burden liabilities.
Implementing the CAG recommendations on NPS reform
The following CAG recommendations on the NPS reforms must be implemented in the meantime:
•A foolproof system needs to be put in place to ensure all nodal offices and eligible employees are registered under NPS
•Delays need to be penalised and compensation affected to avoid loss to the subscriber
•Government to ensure that rules on the service matters are in place for the government NPS subscribers.
The experience so far has been that NPS has given good returns and many experts believe that the annuity is likely to be as attractive as in the old pension scheme, if not better. However, another set of experts criticize NPS due to its uncertainty. There is no doubt that the old pension system will prove to be fiscally unsustainable. Thus current scenario warrants reforming NPS and providing a greater degree of assurance to the subscribers.
THE ECONOMICS CLUB IMI 