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21st September 2023 (10 Topics)

RBI paper on Old Pension Scheme (OPS)

Context

Recently, the Reserve Bank of India (RBI) has warned that the shift to the National Pension System (NPS) in the 2000s was a major fiscal reform. Over time, most states shifted to the NPS, with only West Bengal and Tamil Nadu staying with the old pension scheme, which can have an effect on long-term fiscal stability and compromise the interests of future generations.

The New Pension Scheme (NPS):

  • The New Pension System proposed by the Project OASIS report became the basis for pension reforms and what was originally conceived for unorganised sector workers, was adopted by the government for its own employees.
  • The NPS was for prospective employees; it was made mandatory for all new recruits joining government service from January 1, 2004.
  • Contributions:
  • The defined contribution comprised 10 per cent of the basic salary and dearness allowance by the employee and a matching contribution by the government this was Tier 1, with contributions being mandatory.
  • In 2019, the government increased its contribution to 14 per cent of the basic salary and dearness allowance.
  • Schemes under the NPS are offered by nine pension fund managers.
  • It is sponsored by SBI, LIC, UTI, HDFC, ICICI, Kotak Mahindra, Aditya Birla, Tata, and Max.

NPS vs. Old Pension Scheme:

  • The National Pension System (NPS) is a defined contribution scheme, where the benefits depend on the amount contributed.
  • On the other hand, the old pension scheme is a defined benefit scheme, guaranteeing employees a fixed pension, often set at 50% of their last drawn salary.
  • The old pension scheme places a significant financial burden on the government.

What are the concerns associated?

  • Reverting to the old pension scheme would be much costlier for the government compared to the NPS.
  • According to a Reserve Bank of India study, the additional financial burden of returning to the old scheme could reach 0.9% of GDP annually by 2060.
  • Pensions already consume a substantial portion of state expenditure, with states allocating significant funds for pensions, accounting for a notable share of their revenue expenditure.
  • In the fiscal year 2022-23, states allocated a total of Rs 4.63 lakh crore for pensions, up from Rs 3.45 lakh crore in 2019-20.
  • These allocations for pensions varied among states and union territories, with some, like Uttar Pradesh, Kerala, and Himachal Pradesh, dedicating a higher percentage of their revenue expenditure to pensions.

How NPS is a better option?

  • Freedom to allocate savings: The biggest fear about the NPS is that it redirects subscribers’ money into the ‘volatile’ stock market.
    • But the fact is that NPS subscribers have complete freedom to allocate their savings to equities, corporate bonds or government securities, or any combination of the three.
    • Risk-averse investors can simply allocate all their money to bonds or gilts in NPS, altogether skipping stocks.
  • Beating Inflation:
    • A 20-year analysis of Nifty50, shows that while it frequently delivered losses over one-year periods, stretching one’s holding period to 10 years reduced the loss probability to zero while fetching an 11-12 percent return.
    • While the EPFO has been struggling to declare an 8-8.5 percent return from its ‘safe’ debt portfolio, NPS managers have earned a 13-14 percent returnon equities and 5-9 percent on bonds and government securities over a decade.
  • Greater control:
    • With NPS, an employee has greater control over his pensionas he can save more or allocate more to equities.
    • In the old pension scheme, the employee’s pension is mandatorily limited to half of his last-drawn pay.

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