| No bailouts around the corner
The lives of retired people is likely to become increasingly difficult the world over as grave doubts rise over the ability of governments to deliver the promised retirement benefits in the future. Pension riots have already been reported in China and Latin America. Can India be far behind'
Look at some figures. Between 1995-96 to 2001-02, the consolidated pension liabilities of 29 major Indian states increased three and a half times. The situation is particularly serious in states like Bihar where the pension bill, as a percentage of the state’s revenue expenditure, shot up from 6.57 per cent in 1995-96 to 13.78 per cent in 2001-02. In Jammu and Kashmir, the ratio increased from 2.69 per cent to 9.79 per cent, in Haryana from 3.1 per cent to 6.62 per cent, while in West Bengal it has gone up from 5.4 per cent to 7.15 per cent. No wonder many government employees are not getting their salaries and pensions on time and there is talk of a freeze on dearness allowance.
One universal global factor responsible for this crisis is rising longevity. In most countries including India, the pension system runs on a “pay as you go basis”. Pensions do not come from the contributions a retired person makes during his working life. The contributions of current employees form a common pool from which pensions are paid. But the ratio of current employees to retirees is steadily going down since retired people are living longer and the number of current employees is increasing at a much slower rate.
For India, the last straw was the recommendations of the fifth pay commission. The salary scales of existing employees (after merging DA with the basic pay) were hiked by a minimum of 20 per cent. The hike in salaries was to be accompanied by a reduction in posts and a cut in holidays. When the trade unions protested, some of the cabinet ministers deputed to negotiate a solution sided with them. P. Chidambaram, the then finance minister, reportedly walked out of the meeting in protest. Nonetheless, the salary hike part was lapped up by the majority while the unpopular proposal of “voluntary” retirement of redundant employees and reduction of holidays was shelved.
Monthly pension payments — broadly about 50 per cent of the last pay drawn — automatically went up as salaries were hiked. Further, the introduction of a “one rank one pay” formula implied that whenever the salaries of current employees went up or were revised, pensions for people who had already retired in the same rank were automatically raised.
Family pension paid to dependents after the death of the retiree was also revised upwards. Salaries and pensions were also protected in full against any price rises. The principle of 100 per cent adjustment of DA to price rise had been accepted even before the fifth pay commission. However justified some of these changes may appear, together they broke the back of government finances.
The financial impact was especially disastrous for state governments whose ability to raise additional revenue is restricted. But they had to hike the salaries and pensions in line with the Central government employees. Many state governments are taking loans to meet increasing expenses; many of them are already in the proverbial “debt trap” where they have to borrow just to meet the interest cost on loans.
The crisis will become even more serious in coming years. First, there is the problem of “underfunding”, that is, the growing gap between inflows from existing employees and outflows in the form of pension payments to retirees, past and present. This gap is estimated to be around Rs 60,000 crore.
Then there is the interest rate gap. Provident funds assure tax-free returns of 9.5 per cent, whereas the interest rate on current investments is around 7.5 per cent. This 2 per cent gap in earnings on PF means a loss of about Rs 2,000 crore each year. If this gap is allowed to persist in a falling interest rate regime, a massive government bailout will soon be needed. The problem will become more critical once the bonds, in which the PF funds had been invested and which earned a higher interest rate, mature in a few years. Then the funds will have to be reinvested in lower interest bonds.
Next, what about the quality of assets in which the PF funds are invested' A large part is held in state-government-guaranteed bonds issued by the likes of state electricity boards and river valley projects. There is a grave risk of default associated with these near-bankrupt state undertakings. Also, the guarantee by bankrupt state governments merely means that states will have to borrow more from the market, thereby tightening the noose of the debt trap around their necks. One estimate puts the value of these state government-guaranteed bonds at aroung Rs 50,000 to Rs 60,000 crore.
There is some recognition of the gravity of the problem in government circles. A committee under the former chairman of the Unit Trust of India, S.A. Dave, submitted its old age social and income security report in 1997. It is being debated but no consensus has emerged so far.
What are the possible solutions' The world over, it is now recognized that the “pay-as-you-go” system will have to go. Pensions must be financed from the individual’s own earnings and will go down or up along with the returns on savings. This is unlike the present system where a retired person gets an assured pension linked to his last salary, irrespective of his own contribution during his working life or the interest rate on the money invested.
The Dave committee has suggested many things. Workers should have individual PF accounts built with their own contribution plus that of the employer, and pensions must be financed from the returns on this accumulated fund. PF money should be professionally managed and part of them invested in the private equity market. Finally, individuals may be allowed to choose among alternative pension schemes of private companies. The final solution would be some combination of these various options.
The Dave committee recommendations are in line with prevailing international trends. But lately, countries like the United States of America, Germany, Britain, Japan and Argentina have begun to question this move towards the privatization of pensions. This is the result of several scandals coming to light involving unscrupulous business practices by fund managers and top corporate executives, concealment of information from small investors and the resultant loss of employees’ investments in the stock markets, and the general fear of the dangers of unregulated financial liberalization.
But even as India debates how to go about pension reforms, the pension time bomb continues to tick every day.