Partisan politics apart, the most important fault line emerging in our electoral politics in recent times is between long-term growth and individual, short-term welfare measures. In a poor country with fierce political competition, most of the time short-term political gain will prevail over long-term public good.
Several states switching to the Old Pension Scheme (OPS) from the fiscally sound, defined-contribution pension scheme, designated as National Pension System (NPS), is a regressive move and a danger signal for the long-term health of public finances. Such fiscal profligacy poses the greatest and most proximate threat to India’s long-term growth.
The Vajpayee Government exhibited great foresight in introducing the NPS based on defined contributions by the employee and employer for all new government employees in place of the OPS based on defined benefits without any contribution. All states embraced the NPS for new recruits except West Bengal. The OPS is clearly fiscally unsustainable as there is no pension contribution accruing during the employee’s service, and the burden of lifetime pension after retirement and family pension after death is borne by future generations for services rendered in the past. This burden is multiplied manifold because the pensions are index-linked, and successive Pay Commissions have substantially enhanced the salary and pension benefits of government employees. India is the only major economy that adheres to an unfunded defined-benefit scheme without any contribution to the pension fund while the employee is in service.
Already the pension burden on the exchequer is escalating in many states. The pension liability of state governments has increased sharply from Rs1.45 trillion in FY13 to Rs4.07 trillion in FY22. The pension outgo is 1.9% of the GDP and as a share of all revenue receipts around 13.2% for all states combined, constituting 29.7% of own tax revenues of states. Of the total revenues of states, including Union transfers, the committed expenditure composed of salaries, pensions and interest payments accounts for 56%, leaving little for core governance functions. In FY21, the total committed expenditure of all states stood at a staggering 125% of their revenue receipts. In some states the committed expenditure constituted a higher share of total revenue including Union transfers: e.g.: Punjab 80%; Kerala 73.9%; West Bengal 73.7%; Andhra Pradesh 72.2%.
This is the context in which the Vajpayee Government introduced the NPS in 2004 by broad national consensus. Manmohan Singh’s UPA Government pursued it vigorously. In the Union and all states, the burden of the OPS will continue to rise for several years: But after a decade or two there will be no pension burden under the NPS on the exchequer, because the Government’s pension contributions are made concurrently with the service of the employee, and pension will be drawn from the income from the pension fund in future. This is not only fiscally prudent protection of the future; it is also morally imperative so that the next generation does not pay for services rendered to earlier generations. Indian families of all castes, religions and regions sacrifice present desires for the next generation. Even poor families practise thrift and build assets for their children. Governments borrowing heavily for current expenditure and transferring pension burden to future generations because it is an unfunded defined benefit scheme is alien to Indian society’s norms and culture.
But now several states are yielding to pressures from vocal, highly organised government employees and reversing the healthy trend of the NPS established and running since 2004. In addition to West Bengal, which persisted with the unviable OPS, the states of Punjab, Rajasthan, Chhattisgarh, Jharkhand and Himachal Pradesh have either switched over to the OPS or announced their decision to do so. Unfortunately, short-term political compulsions to attract the votes of government employees are trumping considerations of long-term liability of the OPS. The core functions of government, and resources needed to invest in the future and promote growth, incomes, employment and opportunities for the poor are ignored at the altar of instant electoral gain.
There may even be a perverse incentive encouraging profligate governments to switch over to the OPS. Paradoxically, a state government that switches over to the OPS, while it is seriously undermining the state’s fiscal health and future growth, may in the short term get a bonanza of additional resources to squander as earlier governments and taxpayers acted prudently after 2004 and funded the future pension liability under NPS through annual budgetary allocations. That pension fund constitutes Assets Under Management (AUM). The total NPS assets in AUM have risen 27% in FY22, and stood at Rs7.36 lakh crore. If a state that switches over to the OPS gets back earlier contributions of the Government and employees now in AUM, they will actually have a one-time bonanza to spend more while the burden of pensions on the next generation will rise exponentially. In the absence of restraint and concern for long-term sustainability, all short-term political and fiscal incentives are aligned in favour of profligacy at the cost of growth and inter-generational equity.
A study shows that in case Andhra Pradesh returns to the OPS, the pension burden as a share of total state revenues (including transfers from the Government of India) will rise from the current 11% to 28.6% by 2050 and 38.9% by 2100, far higher than the sustainable 5-7%. The debt to GSDP ratio will rise from 38% now to 53% by 2030 on account of the OPS alone, to 107% by 2050 and 211% in 2100, as against the FRBM norm of 20% of GSDP. Fiscal deficit, currently about 3% of GSDP, will rise to 8.1% by 2050. Similarly, the share of salaries and pensions as a share of the state’s own revenues (excluding Union transfers) will rise from the current 74.1% to 97.7% by 2030 and 129.2% by 2050. The absolute increase in outflow of pensions under the OPS will be astronomical, leading to fiscal collapse and Sri Lanka-like crises in all states that go back to or continue with OPS.
The writing on the wall is clear. A return to the OPS will cause a collapse of public finances in India and condemn the nation to economic stagnation and poverty. Enlightened citizens need to realise this is not about electoral battles; it is the defining battle for our future as a prosperous nation.
The author is the founder of the Lok Satta movement and Foundation for Democratic Reforms. Email: drjploksatta@gmail.com / Twitter @jp_loksatta
