The National Pension Scheme (NPS) currently serves as the framework for government employees’ pensions. Due to the performance of the markets over the past two decades, the market-linked scheme appears attractive. Until 2019, the NPS returned a whopping 13-14 percent on its invested corpus across asset classes. However, the risk component surfaces during economic downturns or bear runs. During events such as a pandemic or recession, the invested corpus could slide in value and be unable to service the pension payouts.
Let’s delve into India’s pension structure, its risks and the NPS’s shortcomings—and evaluate whether Andhra Pradesh’s guaranteed pension system (GPS) could be a potential solution.
Pension schemes are structured on the interplay of benefits and contributions. The defined benefit scheme guarantees employees a fixed pension based on a predetermined formula without them having to allocate a portion of their salaries during active employment. The defined contribution scheme involves employees contributing a fixed amount from their salaries, with the pension depending on the total contributions and the returns generated on it.
The NPS is a defined contribution scheme whereas the model preceding it was a defined benefit scheme called the old pension scheme (OPS).
For government employees, in the case of OPS, the risk of servicing the pension rested squarely on the government as it had to allocate the pension from its tax and non-tax revenues. While the pension payouts were fixed and capped—not higher than a predetermined sum based on the last drawn salary—these were guaranteed by the government. Over time, this caused a colossal fiscal issue.
The Centre’s pension bill grew from Rs 3,272 crore in 1990-91 to Rs 1,90,886 crore in 2020-21—a 58-fold increase. For states, the total pension bill rose 125-fold from Rs 3,131 crore to Rs 3,86,001 crore in the same period. The issue was exacerbated for states with limited tax bases such as Bihar and Himachal Pradesh, where pension liabilities constituted over half the tax revenue.
The two consequences of unsustainable pension liabilities are financial bankruptcy of the state, and increased borrowings and higher taxation. To avoid this, the government was compelled to introduce NPS in 2004. Central government employees commencing service on or after January 1, 2004, were mandatorily placed under NPS. Gradually, all state governments except West Bengal followed suit.
Under the NPS, employees contribute 10 percent of their salary and the government matches this (now increased to 14 percent). These combined contributions form the pension corpus, which is invested and compounds over the course of an employee’s tenure. The aggregate returns—hinged upon the performance of the invested corpus—can be partly withdrawn in lump sum, while the remaining can be reinvested for recurring annuitised monthly payments. NPS eliminated the need for the government to fund the pension entirely out of its revenue receipts.
However, government employees faced a dual conundrum with the NPS. First, they had to fund their own future pension payments. Second, the NPS did not provide assured payouts. The absence of economic certainty eroded their trust in NPS, leaving them exposed to potential financial insecurities at the time of retirement due to unforeseen market oscillations, as demonstrated by American pensioners losing their savings during the 2008 crisis.
These issues made NPS a full-fledged election issue. The Aam Aadmi Party won the 2022 assembly elections by promising to restore the OPS. Rajasthan and Chhattisgarh announced the restoration of the OPS. Today, the OPS vs NPS issue has transcended economic rationale and is pitched as a mainstream political issue, the fiscal ramifications of which are disastrous.
In this context, Andhra Pradesh’s GPS Act of 2023 assumes importance. The politically agnostic state government has refused to band with either of the two national political blocs. It has focused on constructively engaging with the Centre to optimise AP’s developmental interests.
With the state fiscal deficit estimated to touch 8 percent by 2050 if the OPS is restored, the government recognises the perilous financial consequences. Parallely, it acknowledges the concerns about the NPS. After much deliberation, it struck a delicate balance between the OPS and NPS by implementing the GPS.
The GPS is premised on the NPS model but incorporates a defined benefit element. In the event of a shortfall between the net pension amounts under NPS and OPS, the AP government will top up the amount needed to ensure that employees draw a pension that is 50 percent of their last drawn salary. This alleviates employees’ concerns about market downturns and provides a guaranteed pension amount. The GPS retains the contribution framework of NPS, only stepping in to fund the gap between the NPS and OPS pension amounts.
In financial terms, the GPS operates as a principal-protected market-linked debenture (PP-MLD). The reward propensity of an equity instrument is better than a fixed income instrument, but the risk exposure for equity is greater. A PP-MLD balances the risk-reward ratio. The debenture is linked to an underlying index such as the Nifty 50. At maturity, the return will be linked to the movement of the index. It also ensures the investor does not lose if the index slides down. This provides the cushion of a fixed income instrument and the reward prospects of an equity instrument.
Government pensions provide social security to a small fraction of the actively employed, leaving approximately 86 percent of the Indian workforce in the unorganised sector without any formal safety net. In a country with such economic inequities, states spending up to half or more of their tax revenues to support a tiny minority reeks of financial ineptitude, moral irresponsibility and fiscal imprudence. Given the current and forecasted fiscal climate, the Centre and states cannot go back to the OPS, however politically opportune it may appear. With GPS ironing out most of the teething issues that the NPS suffered from, states can either emulate it or stare at a definite financial winter.
(Views are personal.)
Lavu Sri Krishna Devarayalu
Member of Parliament from Narasaraopet
Soumyodeep Halder
Associate, policy engagements, Swaniti Global