Pension Reforms: Short-Term Electoral Gains Versus Long-Term Reform Agenda

India is a country where there is some election happening almost every month (Delhi just recovered from a very bitter local election last month and the stage is set for an acrimonious municipal poll in Mumbai next month). This makes long-term economic reforms difficult to implement.

More so if the benefits are expected to trickle in much after the five-year electoral cycles that political parties now concentrate on. Perhaps the best example of this public finance conundrum is the ongoing political slugfest on the reversal of pension reforms.

In 2004, all states (except the left-ruled West Bengal) migrated to the new pension scheme (NPS) since India’s pension liabilities were becoming fiscally unsustainable.

The NPS replaced the old pension scheme (OPS) where pensioners were given a fixed sum till their life term. The fixed sum was adjusted for inflation regularly via the hike in dearness allowance.

Since OPS was an unfunded and never-ending welfare instrument, it was replaced by NPS which was funded by employees and government and the corpus was professionally managed.

However, the real benefit of the pension reform will become evident from 2034 onwards, thirty years after the introduction of NPS. Most government officials who joined in 2004 on NPS will retire in 2034 and the pension pay outs will start reducing drastically.

Till then, government’s pension commitments will remain high: fulfilling payments to employees under the OPS and allocating 10 per cent of the sum to NPS employees. The budgeted pension bill of all states in 2021-22, the last year before NPS exits began (Rajasthan, Punjab, Chhattisgarh, Jharkhand and now Himachal Pradesh), was a little over Rs 4 lakh crores, around one-quarter of their own tax revenue.

In a decade, though, as the full import of the pension reforms will kick in, this figure will drastically change. And pension reforms will allow precious government funds to be freed for both welfare and investment needs.

Since political parties view time periods only through their lens of five-year electoral cycles, a decade is still too distant in the future. And so what follows are electoral promises of a fixed sum to Government servants, who are influential and form a sizable chunk of votes. A template that five opposition-ruled states have followed in the last one year.

The latest is Congress-ruled Himachal Pradesh, a state with precarious finances since cost of government employee benefits eats up 76 per cent of total tax revenues. This illustrates how burdensome defined-benefit pensions are and the need to not act on political whims.

As per the 2022-23 budget of the hill state, out of every Rs 100 expenditure, Rs 26 was spent on salaries, Rs 15 on pension, Rs 10 on interest payment and Rs 11 on loan repayment. This leaves just 29 per cent of the budget for welfare schemes (and investments for growth). 

This figure will come under further strain since going back to OPS was only half the poll promise, the remaining half is to add another 60,000 government jobs by filling up the vacancies. Reverting back to OPS is a case of present and future generations being made to pay large and ballooning pension bills for previous generations. But the key question is: should a small section of influential voters be allowed to decide the development agenda of a state? 

With nine states up for elections this year, there is a fair chance that this may become a key poll promise. The only deterrent for states can be the fact that the corpus that has so far been collected (investible pool of funds collected by equal contribution by employee and government) cannot be transferred to the State governments.

This means there will be no windfall gains for state finances to dip into. The assets under management of state employees under NPS exceeds Rs. 4.5 lakh crore. For the state of Rajasthan alone, its share in the NPS corpus will be in excess of Rs. 25,000 crore.

The obvious way for Himachal Pradesh to fund this is by piling on additional debt, which currently stands at Rs 74,622 crore. But state governments cannot go on a borrowing spree, since they are bound by fiscal responsibility (FRBM Law).

States can borrow up to 3 percent (H.P. has passed a law to borrow till 6 percent) of their SGDP. All states are indebted to the centre and cannot be allowed to have any leeway in their borrowings. The centre may be forced to rein in the states to ensure fiscal discipline, even if it comes at the cost of allegations of ‘over-reach’.

During the 1990s, several state governments had trouble paying their employees due to the large payouts and the near-insolvent state. In one year, the Assam treasury was shut for 240 days since it couldn’t pay its employees. India cannot return to such a scenario.