The NPS challenge

Business Standard, 4 April 2022

The old pension system was an important threat to Indian fiscal stability. At first, the NPS had the promise of becoming the comprehensive solution to this problem. The NPS is now missing with military personnel, West Bengal, Rajasthan, and a few other states. This is starting to look like an important problem in the fiscal outlook. There has been a loss of institutional memory on fiscal stress, the role of rising pension payments in this stress, and the strategy for solving this through the NPS.

The NPS was born of the fiscal crisis of the late 1990s. Pension payments -- both civil and military -- were growing at an explosive pace. In some states, pensioners were experiencing delays in pension payments. This was a uniquely unnerving experience for the people who had been promised a guaranteed pension. The writing was on the wall, that the promises of stressed governments were not entirely reliable.

Projections for the future showed that things were going to get worse. The old-style pension promises of the Indian state are not affordable with increased longevity. The promises that an employer can afford, when a pensioner will die on average by age 65, are expensive when the expected life span goes up by 10 to 20 years.

This forces difficult choices upon policy makers. It is particularly stark in defence. Indian GDP is a given and we can spend about 2.5% of GDP on defence. This gives a fixed pool of resources. Within this, we face a choice between a small sophisticated military where soldiers have a better chance of surviving and winning battles, versus a weak army with generous pensions.

The NDA-1 and the UPA leadership teams looked hard at these difficult choices and chose the politically difficult path of pension reform. From the viewpoint of a civil servant, it was better to get a block of personal wealth at retirement, and decouple ones own financial planning in old age from the financial problems of the employer at dates deep in the future.

These decisions were shaped by the then-prevalent fiscal stress. The fiscal stress of the union government is best measured as the share of interest payments in net tax revenue. This peaked at 80% in 2001-02. It improved dramatically to 39% in 2007-08. But chronic fiscal stress is not behind us. This value is back up to 48% in 2020-21 even though interest rates are at low values. With weak growth and difficulties in the fiscal system, we are in for a difficult few decades. This is not a good time to revert to more profligate decisions such as going back to the DB pension.

Another problem to contend with is growing longevity. The OPS became unaffordable by 2002, when the Vajpayee cabinet made the decision to introduce the NPS. Over the following 20 years, longevity has gone up. Over the next 40 years, longevity will go up further. Calculations about the OPS need to reckon with the improvements of health in India that take place every year, which drive up its cost.

Pension reforms are a difficult field in that there is a long delay between the hard work of doing the reform, and reaping the gains. For one generation, starting from 1/1/2004, the NPS reform is actually fiscally expensive. It involves paying the old generation the DB pension and the young generation the NPS contribution. The real fiscal gains from the NPS reform lie further out in the future, where elements of the Indian state which manage to do the reform -- and hang in there against attempts at reversing the reform -- will reap substantially greater fiscal health.

The correct calculation involves summing the pension payments visible in state financial statements (which are payments to the old) and the NPS contributions to the young (which are payments to the young, which are not visible in state financial statements). For elements of the Indian state that hang in there with the NPS, this summed value will peak in perhaps 15 years and then start declining and then go all the way to 0.

Without the NPS, e.g. in West Bengal or Rajasthan, or with defence pensions of the union government, pension payments (as seen in conventional fiscal statistics) will just keep growing uncontrollably, until a future reform comes about. For the union civil pension expenses, and for states that are still in the NPS, there is redemption at the horizon. In perhaps 15 years time, the gains from NPS will kick in: total pension related expenses (as defined above) will first stop growing and then gradually tail off to zero.

These difficulties are a cautionary tale on the process of reforms. Like other aspects of improvement of the republic, the work of pension reforms is determined by the quality of the pension reforms community and its discourse. In the 1990s and 2000s, there was a remarkable pension reforms community. Many people thought about the subject, many papers were written, and there was a bubbling discussion on the subject. This community developed the NPS and carried it through into implementation.

In pensions, as in many other elements of policy, the dispersion of the erstwhile policy community removed the intellectual foundation of the policy process. This has adversely affected the policy outcomes of the following years. Policy reform is not an alpine style assault. Establishing a good policy framework means never saying that you are finished. Each field requires a sophisticated policy community, that is analysing and thinking, that is bubbling with the policy discourse, that carries the institutional memory from one generation to the next.

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