Pension off the old

The finance ministry’s decision to liberalise the investment guidelines for trusts, superannuation funds, provident funds, and so on, enabling 5 per cent investment in equity was long overdue. The economic case in favour of equity investment for long-term funds is very clear. In every country, including India, the equity index generally outperforms the debt market over horizons of over 10-15 years. Equity returns generally do not get affected by spikes in inflation. India’s fiscal problem does not directly endanger equity returns, the way it threatens the performance of government bonds. Further, even small differences in the rate of return get magnified over long time spans through the “power of compounding”. These aspects imply that equity index investment is in the best interest of long-term investors. For this reason, the world over, pension funds have systematically increased their equity investments over the last 25 years — UK has a level of 75 per cent.

An augmented flow of equity investment is good for the economy since it is free of fiscal pressures through problems like assured return schemes and administered interest rates. If the stock market goes down, nobody asks the government for a bail-out. The equity market is India’s best experience with a genuine market, free of trading by the government, free of meddling by the government, with uncompromising transparency and modern market institutions, and high levels of efficiency. It allocates resources purely on merit, without distortions introduced by the government. The world admires India’s equity market, and every other developing country aspires to emulate it in this regard.

However, this is also a time to address the issue of regulation of these funds. There are many problems surrounding trusts and funds of this kind, which urgently need to be addressed. All these fund management vehicles are unsupervised. There is every likelihood of a significant incidence of fraud in their operations. These difficulties have nothing to do with equity investment. Given the non-transparency of the bond market, the dangers of fraud are actually greater with bond investment, as seen with the recent scandal surrounding Seamen’s Provident Fund. The instinct to liberalise investment guidelines needs to be simultaneously accompanied by the creation of a modern regulatory and supervisory capacity. The government did well to put out an ordinance for the creation of Pension Fund Regulatory and Development Authority (PFRDA). There is a genuine urgency in the creation of PFRDA. However, the government has done badly by letting the weeks go by without acting on this ordinance. The urgently need to bring a first-rate management team, with competence in pensions and finance, into PFRDA, so that India can begin the task of setting up a modern pension regulator.