A Return By Some States To The Old Pension Scheme Is 'Fiscal Hara-Kiri': SBI Economic Research

Years after most Indian states migrated to the National Pension Scheme, leaving behind a fiscally imprudent 'pay as you go' scheme, two states have chosen to bring back the old way of providing for pensions.

In the recent state budgets, Rajasthan and Chhattisgarh said they will revert to the old pension scheme. Were this trend to continue, it would be fiscal "hara-kiri", said State Bank of India's Economic Research division in a March 24 note.

Under the old PAYG scheme, which existed until 2004, the contributions of the current generation of workers were used to pay the pensions of current pensioners. This made it an unfunded pension scheme that involved a direct transfer of resources from the current generation of taxpayers to fund the pensioners, the research note explained.

As such, it was a clear fiscal burden.

According to SBI Economic Research, any large-scale return to that scheme would not be viable.

Trends in the pension liability of state governments over the long run shows a very sharp increase, an analysis by Soumya Kanti Ghosh, group chief economic adviser of State Bank of India, found. The compounded annual growth in pension liabilities for the 12-year period ended FY22 was at 34% for all the state governments.

As of FY21, the pension outgo as percent of revenue receipts is around 13.2% for all states combined and 29.7% of own tax revenue.

PAYG financing can also mask the long-run cost of promised pension obligations, the note said. One way to estimate it is to quantify the present value of this future stream of expected benefits known as the “implicit public pension debt”.

This implicit debt is a complicated function of the number of workers and retirees, entry age of workers, the expected life spans, the size of the average benefit, the retirement age and the discount rate used to calculate the present value.

Consolidated data given by NPS Trust shows that there are 55.44 lakh contributing state-level employees as of February 2022. If we assume that all states migrate to the old scheme, and assuming an entry-level age of 28 years, with a 5% inflation indexation, the current present value of the implicit pension liabilities is around 13% of GDP, discounted by the current government securities yield on 40-year securities.

Third, India’s demographic profile is currently undergoing a structural change with declining fertility, increasing longevity and ageing southern states coupled with young northern states.

By 2050, India’s population will be 164 crore, of which 32 crore will be of age 60 years and above. The old-age dependency ratio defined as the number of persons 60 years and over per 100 persons of 15 to 59 years age is expected to touch 23% by 2036, compared to the current 16%. This imposes significant demands on the working-age population.

This was the reason that in 2003, India moved to the New Pension Scheme, which was a defined contribution scheme. Twenty-seven states joined the scheme between 2003 and 2005. According to the NPS, the government makes a 14% matching contribution against the 10% monthly contribution of employees.

The sudden reversion to old pension scheme, that too with retrospective effect, is bound to increase the current expenditure of the state governments, said the note, adding that the actual affect of the decision will be felt from 2035, although this may differ from state to state.

To be sure, as of now no state has made a formal request to withdraw from the New Pension Scheme, the report clarified.