How to tackle informal sector pensions

Business Standard, 6 December 2006

The UPA has spent 2.5 years unsuccessfully grappling with the left when it comes to the PFRDA Bill. The situation is less gloomy than meets the eye. The implementation of the New Pension System (NPS) does not require the PFRDA Bill. Within a few weeks, if the PFRDA Bill is not passed, the government has the choice of proceeding on implementing the NPS. This will be a second-best implementation, for it will not have the regulation that would be enabled by the PFRDA Act. But the brunt of the task ahead on the NPS consists of building IT systems - regulation is not the central constraint for a few years. After the next general elections, the prospects for the PFRDA Bill look good, because it has support from all parties other than the Left.

While the NPS is seen as being about the civil servants pension, the design of the NPS equally caters to the requirements of the informal sector. This is related to the origins of the NPS in `Project OASIS', setup by the Ministry of Social Justice and Empowerment (MOSJE) in the late 1990s. MOSJE understood that the problem of ageing was very real, and that giant dole programs were not going to work. This led to a quest for a modern administrative structure through which savings of millions of households could be efficiently collected and invested so as to earn the highest possible rate of return. This led to Project OASIS.

A remarkable feature of the early thinking of Project OASIS was the engagement with NGOs who work closely with MOSJE. NGOs like SEWA were clear that they had the ability and interest in talking with poor people, establishing pension accounts for them, and helping to ensure a steady contribution flow. What the NGOs did not have was the "back-end" - once a contribution flow was in hand, they did not know what to do with the money.

As an example, Grameen Bank in Bangladesh has done one thing right: they have an enormous push in favour of pension accounts. Every borrower is forced to open a pension account and start contributing atleast 50 Taka per month. This encourages preparing for old age, based on thrift and self-help; not an approach of being a supplicant trying to beg for food from a government in old age. Grameen Bank has roughly 7 million accounts. But Grameen Bank does not know how to handle the back-end. They have an administratively set 12% return, which is simply infeasible. As their customer base builds up, they will face a financial crisis, and be forced to renege on this assured return. The weak "back-end" will undermine the good work of opening accounts and garnering contribution flow.

The NPS has no such mistakes lurking within, which can lead to a catastrophic failure in the years to come. There are no promises of assured return, and there will be a regulator supervising investments and disclosure. India could, then, have an ideal combination of the NPS back-end - with top quality IT in the Central Recordkeeping Agency and competition between professional pension fund managers - linking up to mass action by NGOs and other organisational structures which interact directly with participants in the informal sector.

In recent months, important developments have taken place through the initiatives of UTI and Sewa Bank, where there has been an effort at operationalising pension accounts in the informal sector. Such initiatives are important and worthwhile; even while the implementation of the NPS is stranded, this should not block all progress. In the future, it will be possible to merge these efforts back into NPS.

As UTI has emphasised, there is a very large potential for occupationally oriented outreach programs. The association of taxi drivers in Bombay is the ideal path to account opening and contribution flow from taxi workers of Bombay. Amul and the `white revolution' has thrown up organisation structures in the nationwide supply chain for milk. Many ministries have the knowledge and organisation capacity to reach occupational groups. As an example, the Ministry of Textiles has the skills and operational capacity to setup a pension program for weavers. The Ministry of Education has a corresponding position when it comes to teachers in private schools. Through these approaches, expansion into the informal sector is likely to be the most fascinating feature of the NPS.

There is a cautious case for support from the State by co-contribution alongside informal sector participants. On one hand, this is an argument of fairness for informal versus formal. In the formal sector, tax-advantaged pension contributions entail a fiscal subsidy. Fairness demands a comparable treatment for informal sector participants. Further, suppose the NPS fails to attract a person and put him on the path of thrift and self-help. This person is likely to fall back on poverty programs of the government in old age. It is better to replace that unpredictable future liability by a controlled expenditure today which can be budgeted for.

If 100 million workers in the informal sector get a subsidy from the government of Rs.100/month, this works out to a cost of Rs.12,000 crore per year. A program of this size would be a spectacular success, bigger than any existing welfare program of GOI. If this subsidy is conditional on a personal contribution by the participant of Rs.200/month into the NPS, it amply achieves the goal of escaping poverty in old age. If this is scaled up to 300 million people, it is a fiscal cost of 1% of today's GDP while inducing an NPS contribution flow of 3% of GDP.

This welfare expenditure is administratively feasible and makes economic sense. It involves transfer of cash directly from the Ministry of Finance to the Central Recordkeeping Agency. An fiscal expense of Rs.100 is leveraged into a magnified flow of Rs.300 per month going into the NPS account: this is a more efficient use of scarce public money.

Over the years, the participant would see growing personal pension wealth in his NPS account statement, which gives a confident outlook. Having a tidy pile of pension wealth changes many things ranging from fertility choice to coping with the inevitable fluctuations of the market economy. It puts the person on his feet in old age, shifting away from culture of dependency on government welfare programs.

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