Opinion Rebooting pensions

The act will allow greater private sector participation in the pension sector,which shall usher in more competition and product differentiation. The pension sector will also open up to foreign direct investment,with a cap of 26 per cent as per the current provisions,which will be increased automatically to 49 per cent once FDI in insurance is approved to the same extent. These are significant steps towards greater financial sector reforms,and will help in a healthy and disciplined growth of the pension sector,spearheaded by its own old-age retirement scheme,the NPS.

The NPS,which captures elements of both systematic investment and pension planning,has had limited success in terms of coverage and assets under management (AUM). The NPS is mandatory for all Central government employees (other than the armed forces) who joined service in 2004. The scheme has been open for voluntary subscription since May 1,2009. Till August this year,the subscriber base,including government employees of 26 state governments who have adopted the NPS,stood at 52.83 lakh,amounting to a meagre 1.15 per cent of India’s total workforce of 460 million. The total AUM was Rs 34,965 crore in the same period. This is expected to change over the next few years as a statutory status to the PFRDA could help move a significant sum from the superannuation schemes of the private sector,estimated to be over Rs 10 lakh crore,to the NPS.

The act has provisions for subscribers to opt for minimum assured returns on specified notified schemes. Depending on an individual subscriber’s choice of risk-return portfolio,the NPS will continue to offer market-linked schemes through a variety of investment choices such as equities and government and corporate bonds,managed professionally by public and private pension fund managers. A premature withdrawal facility has also been provided. This will make the modified scheme more attractive to investors.

However,from a long-term perspective,the PFRDA,given its role as a development authority,will also need to look into the following.

First,the NPS currently comes under the exempt-exempt-tax system with the maturity proceeds liable to be taxed for the subscriber. As a result,many investors prefer alternatives such as the EPF,and even the Equity Linked Savings Scheme (ELSS),which provides complete non-taxable withdrawal after a specific time period and comes with greater liquidity. However,under the DTC,the maturity proceeds from the NPS are slated to be non-taxable,putting it under the purview of exempt-exempt-exempt tax system. Thus,there is an urgent need to implement the DTC provisions that will bring about parity and make the scheme investor friendly.

Second,one of the major drawbacks of the current pension scheme is its restrictive investment mandate. For example,investments in IPOs or FPOs are not allowed,there are restrictions on investment in debt markets,coupled with prohibition on investment in ETFs and equity-oriented mutual funds. Investments in equity of any unlisted companies are also disallowed. In contrast,pension funds are one of the major contributors in infrastructure financing done through unlisted equity,fund of funds,and structured debt in developed economies. As per a joint study conducted by OECD and Oliver Wyman,many pension funds invest more than 10 per cent of their total portfolio in infrastructure as equity. Thus,the restrictions essentially inhibit the flow of much needed capital in the infrastructure sector. Further,restricting the investment mandate to very few alternatives not only caps the return,but also has implications for risk management.

Going forward,with the acquisition of necessary resources for proper due diligence and risk management,the investment mandate should be broadened to allow these pension funds to invest in international assets,as is done by many large mature pension funds.

Third,the provision of assured returns is a step backwards. It defies the basic spirit of a defined contribution scheme. Also,the possibility of inflation-indexed returns,though beneficial for the subscribers,will put fund managers under pressure,especially when the availability of similar investment options is limited,with the recently launched inflation-indexed bonds market still at a nascent stage.

The PFRDA will,apart from regulation,also have to play a major role in developing a framework that focuses on promoting financial literacy in the uncovered workforce,outlining the benefits of migrating to such a system. The act is a step in the right direction,but a proper regulatory environment and institutional mechanism needs to be put in place before its twin objectives of attracting incremental capital to develop capital markets and achieving social security for the old can be successfully achieved.

Santanu Kundu