The way forward with one-rank-one-pension

by Ajay Shah and Renuka Sane, Indian Express, 27 August 2015

Emotional arguments are being made about one-rank-one-pension. One-rank-one-pension constitutes a sharp escalation in pension payments for military personnel, which could have implications on a GDP scale. Before any decisions are taken, careful calculations should be made. This episode is a reminder of the importance of building the New Pension System.

When a pension promise is made to a 20 year old soldier, who will draw the pension from age 35 to age 100, the stream of payments are spread over the coming 80 years. We should work out the present value of these payments, and not just look at the expenditure in 2015-16. A careful calculation shows that for a pension that starts at age 60, shifting to one-rank-one-pension is a hike in the lump sum value of the pension of 94%. For a pension that starts at age 35, introducing one-rank-one-pension is a hike in the lump sum value of the pension of 233%. As 80% of military staff start drawing a pension at age 35, the latter number looms large.

These are relative estimates of how much costlier will one-rank-one-pension be. In absolute terms, how big are the magnitudes? We do not know. The government has not released the values, and external experts are not able to make the calculation. But one illustration will help show the magnitude of what is at stake.

In 2002, when the NDA government was evaluating pension reforms, Surendra Dave and Gautam Bhardwaj made a calculation for the Ministry of Finance which showed that the lump sum value of all civil servant pensions was roughly 60% of GDP. Even though civil servants are a tiny fraction of the workforce, the promises associated with paying them pensions were almost as large as the total public debt that was then prevalent!. This calculation helped to spur the government into building the New Pension System, and to place all new recruits from 1/1/2004 into the NPS. Similar calculations are essential, before any decision is made on one-rank-one-pension.

The bond market and credit rating agencies see that pension promises are practically like taking on more debt. They increase the indebtedness of the government, reduce its creditworthiness and increase the cost of borrowing. Every Indian suffers from a higher cost of borrowing when the government's creditworthiness goes down. India is barely within the ranks of "investment grade" credit ratings. A decision to have one-rank-one-pension could potentially knock off India out of this category, and it could take decades of fiscal austerity in order to climb back.

Emotional arguments are being made that any payment is justified if it will make India strong. However, the best way to make India strong is to reduce the indebtedness of the government. Or, it can be argued that each $10 billion of increased public debt could be used to buy one aircraft carrier. Do we want a few dozen aircraft carriers or do we want one-rank-one-pension?

If one-rank-one-pension is introduced for military personnel, the courts could potentially force its adoption for civil pensioners also. This would substantially increase the overall cost. This scenario needs to be factored into the thinking.

We are faced with the political crisis of one-rank-one-pension today because, many years ago, we faltered on pension reform. In 2002 and 2003, when the New Pension System was being implemented for all new recruits into the civil service starting from 1/1/2004, the thinking was that once the NPS stabilises, it would be extended to new uniformed recruits. Unfortunately, there was a loss of continuity and institutional memory. This extension was never done. In addition, the NPS shaped up significantly inferior to what was originally envisioned.

We must make the NPS work really well, so that it is a well functioning and attractive pension system. We must zealously guard the NPS and ensure that it is not contaminated with guarantees or defined benefits of any kind. NPS assets are now below 1% of GDP. They need to go up to over 200% of GDP, in order to take care of today's workforce as it ages.

We must continuously work to enlarge coverage of the NPS, so as to head off the political crises that will continue to erupt as we face problems of old age and pensions in coming years. Building and continually extending the NPS is important but not urgent. It is all too easy to put it at low priority. However, cutting corners on this work will generate a succession of wrenching political crises such as the situation with one-rank-one-pension today.

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