Mukul G Asher
First of a 2-part series
The reported decision by the Finance Minister to soon notify an interim investment pattern for the Central Government’s New Pension Scheme (NPS), in effect since January 1, 2004, is a modest but long overdue welcome step.
Along with the investment pattern, arrangements for the Pension Fund managers as well as designation of the Central Recordkeeping Agency (CRA) can also be expected to be announced.
It is highly probable that the fund managers and the CRA, both an integral part of the overall design of the NPS, will initially be from the public sector institutions when the interim arrangements are announced.
Such a process requires a professional, well-resourced, and competent independent regulator.
Thus, the announcement of interim arrangements should also involve strengthening of the interim Pension Fund Regulatory and Development Authority (PFRDA).
The current accumulations under the NPS for the Central government employees are deposited under the Public Account, drawing an administered interest rate of 8% per annum.
The media reports have focused primarily on the fact that up to 5% of the accumulated balances can be invested in equities.
In other words, they are concluding that an insignificant sum would trickle into the markets given the current market capitalisation of Rs 38 lakh crore.
This is not an appropriate way to analyse the implications of the interim investment pattern.
First, the investment pattern will provide choice to individuals between gilts, corporate debt, and equities.
The RBI has emphasised the need to develop the corporate bond markets; and the importance of investments in long-term maturity bonds for infrastructure and other products.
The primary economic impact of the interim investment pattern will thus be to channel these savings, in accordance with the preferences of the individual members, into financial and capital markets in a transparent manner.
As NPS permits accumulations till retirement, it enables members to reap the benefits of compound interest over a prolonged period.
The long-term liability of the pension funds can therefore be in part matched with long-term bonds as assets. Excessive emphasis on just a small portion being invested in equities is therefore misplaced.
Second, the accumulated sum refers to only the covered Central government employees at this point in time. Armed forces are not covered by the NPS, but they have been accumulating pension reserves and investing in the financial and capital markets.
With each year, even assuming no net increase in the number of employees (number retiring are equal to number recruited), the membership in the NPS will continue to grow, and so will the amounts available. The cumulative impact over a prolonged period will be significant on both the debt and the equity markets.
Third, in addition to the centre, 19 state governments have acted to implement the NPS. In principle, each state can decide on the design of its own NPS, in practice, the states would like the centre to take the lead.
They rightly prefer to make their schemes broadly compatible with that of the centre, particularly as the long term nature of the pension scheme makes the role of PFRDA crucial. It is not efficient to have each state set up its own regulatory authority.
Reports suggest that many states are impatient with the indecisive behaviour of the centre in implementing the NPS.
States — reportedly West Bengal, Kerala, and Tripura— not inclined to reform their pension systems, are free to do so. But they should not be permitted to obstruct the reforms clearly desired by the vast majority of the states, constituting overwhelming proportion of India’s population.
The total number of government employees in India is around 17 million, with the states employing nearly four times the number employed by the centre.
Once the centre announces the interim arrangements, the progress in implementation of the NPS on the part of the many states will be more rapid. The pension accumulations will grow quite rapidly once the 19 states notify their own investment patterns.
Currently, the states with the NPS are also accumulating balances in the Public Account and paying administered rate of interest. A modest step by the centre therefore could generate significant positive impact for pension reform in the states; and for financial and capital markets in the medium term.
It is essential that along with growing pension assets, supply of investment grade debt and equity instruments also increases. This will bring depth to India’s financial and capital markets, and permit better risk management.
To realise the full benefits of the NPS, the interim arrangements should however be followed by the demonstration of the political will on the part of the UPA government in passing the PFRDA Bill as quickly as possible.
This will be analysed tomorrow.
(The writer is professor of public policy, National University of Singapore)