Civil service pensions have traditionally been financed by a pay-as-you-go system where the pension benefits are defined and largely unfunded and pensions are paid out of state revenues. Till recently, the cost of pensions have never been the focus of attention, only the benefits were. It has always been assumed that should these costs rise sharply the state can always raise revenue by raising taxes.
Much of this has changed now. The pay-as-you-go schemes are maturing, resulting in an increase in the ratio of pensioners to workers and in the magnitude of the pension share in public spending as well. Several countries which find themselves beleaguered by mounting pension liabilities under the defined benefit schemes have decided to move to the defined contribution system which provides a better linkage between contributions and benefits, prevents accumulations of funding deficits or unfunded liabilities, and imparts long run fiscal sustainability to the pension system.
In keeping with these developments, the Government of India had recently decided to shift from the defined — benefit pension system that was prevailing in the civil services so far, and move over to a scheme based on defined-contributions. Pensions henceforth will no longer be linked to employees’ final salary but instead be determined by the returns on investments that employees earn on their contributions along with a matching contribution by the government .The New Pension Scheme (NPS) is applicable to those entering service from January 1, 2004.
While Indian Railways (IR) has also adopted the NPS, the changeover is unlikely to improve its financial picture in the near future. There are two factors that must be recognised. First, the cohort of railwaymen, numbering almost 1.4 million that were in service on the switchover date to the NPS will continue to be governed by the old defined benefit scheme so that their pensions will remain a charge on railway revenues for several decades.
The rising graph of the railway pensioners cannot be ignored either. Their number was only 1.03 lakh in 1975-76, but increased to 6.86 lakh in 1990-91, and then to 11.45 lakh in 2007-08. This number is likely to increase for some more time because of the steadily rising life expectancy, and may stabilise thereafter. Second, and this assumes some significance, it will be a double whammy for IR, because till such time that all pensioners under the defined-benefit scheme exit the system, not only will the railways be bearing expenditure on their pensions but also on the NPS contributions for the new entrants.
IR’s combined expenditure on salaries and pensions was just `1, 317 crore in 1980-81 but rose to a staggering ` 51,237 crore in 2009-10, forming nearly 59 per cent of railway’s expenses. A similar trend in the coming years, to which the future pay commissions will be contributing in no small measure, may multiply the staff cost several times over.
At the same time, increasing amounts will be required towards NPS contributions, related as these are to the gross salaries disbursed. Together, these will be taking away a large slice of railway revenues. By around 2040, of course, most of the current and eligible pensioners would have gone, which will bring down the pension expenditure substantially. But this is still a long time away, and till then something needs to be done to ward off pressure on IR’s budget and lend its finances some semblance of stability.
One of the strategies could be to set aside amounts, estimated on an actuarial basis, into a newly created fund for meeting expenditure on the annual NPS payments. This can help IR in meeting its NPS obligations, obviating the need for raising additional resources, especially for the years when pensions under the old defined-benefit scheme are also to be provided for.
There is a distinct sense of déjà vu. In 1964, IR had decided to build up a pension fund, on an accrual basis, to take care of the future pension liabilities. Sadly, the fund — in the manner that it was contemplated- became virtually non-functional after a few years. Other demands on railway’s business took precedence. Today, IR is paying a heavy price for this neglect. Now that its expenditure on pensions has ballooned from a meagre `85 crore in 1980-81 to `14,500 crore in 2010-12, the railways are left scrounging for resources for meeting its pension obligations. Worse, based on an actuarial evaluation carried out a few years ago, IR’s accrued pension liabilities, both for the existing and eligible pensioners, were estimated to be a whopping `5,40,000 crore. With hardly any balance left in the pension fund, there is a huge assets-liabilities mismatch. This exacerbates the problem.
Railway budget was separated from General budget in 1924 to introduce flexibility in the administration of railway finances and to secure stability for civil estimates by providing for an assured contribution from railway revenues. However, the railways were never allowed either the freedom to expand or the freedom to plan for themselves without being fettered by the general finances. With IR’s financial ruin staring it in the face, it is time for the government to have a serious re-think on the autonomy that ought to be granted to IR in order that it can act with a greater degree of independence and thereby restore the desired level of profitability in its operations. Or else, it is best to terminate the eight -decades-old arrangement of having a separate railway budget, and instead have only a status paper presented each year to indicate what the Railways have done, a suggestion made by a former railway minister several years ago.
S N Mathur is Former Managing Director, Indian Railways Finance Corporation.
e-mail: mathur.surendra@gmail.com