The UPA-II government’s decision to move ahead with a set of 20-odd measures, some of them quite contentious, is a political gamble, even while it seeks to reinforce the ‘reformist’ tag. Arguably, the most eye-catching of the announcements, which Finance Minister P. Chidambaram made on Thursday last, have to do with the insurance and pensions sectors. The hike in the foreign direct investment (FDI) limit in the insurance sector to 49 per cent from the present 26 per cent, with a proviso that the pension sector can also receive foreign money to the same extent, are two measures that promise to be the most contentious.
Unlike the previous ‘big bang’ reforms such as throwing open multi-brand retail trade to FDI, which do not require legislative approval, the enhancement of FDI in the insurance sectors needs Parliamentary clearance. Even in these early days after the announcements, there is plenty of speculation as to how the UPA government will get these amendments passed, especially as it lacks a majority in the Rajya Sabha.
A logical question is why should the government risk so much in pushing for FDI in the insurance and pension sectors. These proposals are not new. In fact, they have been debated at the Parliamentary Standing Committee. However, the cap on FDI as agreed to was 26 per cent in the pensions sector on a par with what obtains in the insurance sector. That, however, was of academic value. In the absence of a statutory regulator, pension reform was a virtual non-starter. The question of investment by private, including foreign players, did not arise.
The regulator is the key
Interestingly, the Pension Fund Regulatory and Development Authority (PFRDA) Bill, first mooted seven years ago by the then NDA government, was also cleared by the government for Parliamentary approval. It is hoped that its eventual passage should not be as difficult as raising of the FDI limits. However, it must be emphasised that as recently as November, 2011, the government failed to get the crucial Opposition support over a relatively technical issue: whether to specify the FDI cap (of 26 per cent) in the PFRDA Act itself or in the rules to be framed after the enactment. The BJP wanted it to be built into the Act while the government wanted it to be notified under rules as it would get flexibility to vary the cap if needed.
The political atmosphere has become vitiated since November, and it is doubtful whether even the degree of consensus, which was obtained 11 months ago, would be valid today.
The more important point is that disagreement over the size of the FDI cap may overshadow the moves to empower the PFRDA. Hopefully, that should be a blessing. With a statutory status, the pension regulator can preside over the orderly opening up of the sector, which, today, has been unable to deliver even the minimum that is called for, and has left large sections uncovered. According to reliable estimates, only a very small percentage of India’s workforce, of roughly 420 million, are covered under some formal pension scheme or the other. The main reason is that the government simply does not have the money to expand the scheme or even keep it afloat. Increasing longevity and the break-up of the joint family system have brought to the fore the serious chinks in India’s social security armour. The fiscal implications to the government of shifting from defined benefit under the old system to defined contribution, which is the characteristic of the new order, are enormous. They explain why not just in India but in many other countries guaranteed pension for their employees has left a gaping hole in their public finances.
Be wary of stock market hype
The PFRDA will regulate pension schemes, which invest the defined contributions of employees and generate market-based returns. Therein lies the rub. Investments in stock markets by pension funds are fraught with serious risk. While some of the numerous detractors of such schemes might be mollified by an assurance of a minimum return, it might be beyond the capabilities of the fund manager to deliver on such promises consistently even assuming that the rules allow him to make such promises. For those who want to play it safe, schemes that invest wholly or predominantly in debt instruments should be a good bet. However, compared to the ‘glamorous’ equities, the debt market, consisting of the corporate bond market besides the gilts, may not be deep or attractive enough to absorb the large funds that may come in. It goes without saying that investor education is a must to guide the pension fund subscriber consistently. This brings us to the main reason as to why the government is so keen on pushing ahead with insurance and pension sector reform. They are the largest reservoir for infrastructure funds, which the country badly needs. Insurance and pension funds target the long-term savings of households and invest in long-dated anti-cyclical securities.
However, in an interesting parallel with the opening up of retail trade to multi-nationals, overseas insurance companies, pension funds and other serious investors may not flood the Indian capital market straightaway. It is better to view the government’s latest proposals as being relevant for the long haul.
It is a pity that this important benefit is not stressed upon by the government. The needs of infrastructure are huge. Surely, an ideological battle over FDI cap is uncalled for at this stage?