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ShareIndia's current demographic phase is marked by a rising share of young workers in the total labour force. The global economic and technological dynamics and India's labour market trends strongly suggest that formal employment-based and mandatory state-managed pension systems will not be able to provide sustainable retirement support to the majority of the labour force.
There is, therefore, an urgent need to construct robust and well-regulated voluntary retirement financing arrangements, which inspire confidence among all stakeholders.
The recent decision by the government to broaden the scope of the New Pension Scheme (NPS) to all Indians, on a voluntary basis, represents an important milestone in India's pension reform process. The interim Pension Fund Regulatory and Development Authority (PFRDA), whose mandate was just renewed, has been entrusted with operationalising this decision by the first half of 2009.
The PFRDA has taken significant steps towards establishing the operational and regulatory architecture for the mandatory component of the NPS, which currently covers the central government employees employed since January 1, 2004. It has built up an estimated corpus of Rs 4,000 crore. The PFRDA has already appointed National Securities Depository Ltd (NSDL) as the central recordkeeping agency (CRA).
Currently, three public sector fund managers -- Life Insurance Corp, UTI Asset Management and State Bank of India -- have been appointed. However, the individual member data is yet to be transferred to the CRA.
To realise economies of scale, it is essential that the 21 states which have so far opted for the NPS be encouraged to utilise the services of the CRA appointed by the PFRDA.
Before broadening the NPS coverage on a voluntary basis, it is imperative that the pending PFRDA Bill 2005 be passed by the Parliament during the session starting October 17. There are indications that the Insurance Bill, raising the foreign investment limit from 26% to 49%, is to be introduced in the October session. Passage of both these Bills will lend greater clarity and stability to the legal environment concerning both the accumulation and the payout phases of the NPS. Currently, annuities in the payout phase can only be issued by life insurance companies.
In addition to the passage of the PFRDA and Insurance Bills, there is a need to harmonise the tax treatment of different types of retirement savings. The NPS is tax-disadvantaged as compared with other retirement saving options, such as the Employees Provident Fund Scheme and the Public Provident Fund, which are fully tax-exempt. Currently, the NPS is taxed when the payout phase begins.
To make the voluntary NPS work, the PFRDA must satisfactorily address a complex set of issues. These involve providing necessary incentives to distributors; determining the frequency and the amount of contributions by members; developing appropriate investment products; selecting fund managers and determining the terms and conditions for their services; and designing options for the payout phase. Improving financial literacy of all stakeholders in general, and pension literacy in particular should also be given due attention.
In each of the above areas, the PFRDA will need to decide whether the arrangements appropriate for mandatory component of the NPS are also appropriate for the voluntary component. The decisions by the PFRDA to set up an expert group to advise on the investment patterns and choices to be offered to members; and to appoint an institutional advisor are steps to be welcomed. The PFRDA will, however, need to develop an organisational culture that is receptive to outside expertise if these steps are to lead to more effective regulatory policies and practices.
The current CRA can continue to be utilised for voluntary members until the scale considerations warrant additional CRAs.
For pension fund managers, the PFRDA should insist on appropriate risk management practices. The pension arrangements should be sustainable and robust over a long period. The Indian pension regulator, therefore, should ensure that high-yielding but very risky asset classes and financial engineering practices are actively discouraged. The main advantage of the long-term contractual pension (and insurance) savings is the
predictability with which they can be channelled into economic growth-enhancing productive assets, thereby raising the future capacity of the economy to sustain living standards. The NPS could also lend greater stability to debt and equity markets by increasing the weight of domestic institutions.
The current financial turmoil in the global markets has underscored the fact that confidence in the financial and regulatory environment is vital for sustaining high growth, but can be easily eroded if appropriate monetary and fiscal policies are not pursued.
In the Indian context, excessive recourse to short-term, economically counterproductive and populist budgetary spending, and neglect of administrative reforms designed to improve delivery of government services are especially unwarranted, and need to be urgently corrected. India will find it increasingly difficult to finance its large trade and current account deficits without more conservative fiscal policies.
Moreover, even with effectively implemented NPS, social pensions for the elderly poor, financed from the Central and State government budgets will be essential. This will require fiscal and service delivery reforms.
The financial institutions and the media should also contribute constructively in educating the general public about the benefits of voluntary participation in the NPS. The members must be made aware of the long-term nature of retirement savings, and the relationship between risk and return on investments.
For voluntary NPS members, the PFRDA may consider modifying the current arrangements for the payout phase. Instead of mandatory conversion of 40% of the accumulated balances into an annuity at the time of retirement as is currently required, phased withdrawal plans merit serious consideration. Such plans permit individuals to withdraw at periodic intervals in a manner which exhausts principle plus interest over a set period, such as 15 years. This enables individuals to retain ownership, benefit from compound interest and may enable some social risk pooling through limited interest subsidy. The existing mechanisms (such as dada-dadi type bonds) could be used, with maximum amounts specified for limited social risk pooling in the payout phase.
It is widely acknowledged that individuals will need to make greater provision for their growing retirement needs. The NPS architecture has the potential to provide necessary confidence and incentives for individuals to voluntarily save for long-term retirement, and increase the weight of domestic institutions in India's capital markets.
The PFRDA needs commitment to competence, and requisite autonomy and resources to turn this potential into reality.
The writer is professor of public policy, National University of Singapore and can be reached at mukul.asher@gmail.com.
Views are personal.
