The Hindu : Action plan to tone up pension system

Online edition of India's National Newspaper
Friday, May 09, 2003

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Business

Action plan to tone up pension system

By Oommen A. Ninan

MUMBAI MAY 8 . As the Special Deposit Scheme (SDS) of the Central Government with a corpus of Rs. 125,365 crores matures on June 30, many issues on pension and provident funds are yet to be clarified by the Government.

Established in 1952, the Employees' Provident Fund (EPF) was gradually extended from 5 to 179 industries. Nevertheless, the labourforce coverage has barely risen from 1 per cent to 5 per cent. High rates of withdrawal from account balances, a fixed retirement age and investment returns below income growth combine to produce inadequate balances at retirement. Since 1995, part of the provident fund has been converted to a defined benefit scheme, but projections show that unless the real value of benefits is cut, the scheme is not sustainable.

The World Bank study recently has highlighted the adverse effects of the pension system on the rest of the economy. The growing fiscal burden of the civil service scheme threatens to 'crowd out' financing of other programmes and to add to India's burgeoning deficit. The Employees Provident Fund Organisation (EPFO) helps to finance this deficit by investing exclusively in government-guaranteed debt but, as a result, deprives the economy of an important source of long-term finance. The perception that mandated contributions are largely a tax on labour encourages informal sector activity. In March 2001, the Union Government announced changes, including the introduction of a contributory scheme for civil servants and a new scheme to cover informal sector workers.

The progress has been slow as it is only two years later, that is, in 2003, the Finance Minister, Jaswant Singh, has promised to introduce a contributory scheme for new government employees.

Meanwhile, there are no plans to reform the EPFO schemes and voluntary and private pensions continue to develop in a regulatory vacuum. "Five action points, which would benefit the provident and pension system immediately, are: first, securitise SDS, second, allow the pension and provident funds to swap their investments and introduce duration based trading, third, change the guidelines regarding corporate paper, four, grant exemptions (from the EPS'95 scheme) to financially vibrant employers, which will bring down the Government liability as incurred for additional contributions to EPS'95 and will consolidate the second pillar and five, introduce a menu-based system for asset allocation,'' said Baman Mehta, Chief Executive Officer, Darashaw & Company, a pioneer in the provident funds and pension funds industry.

The most critical issue that the provident funds are concerned is the SDS, which was launched by the Central Government on July 1, 1975. The purpose of the scheme was to provide better returns to non-government provident funds, superannuation and gratuity funds, surplus funds of the Life Insurance Corporation (LIC) and Employees' State Insurance Corporation.

Initially, the scheme was supposed to be only for ten years. Subsequently it was extended for another ten years in 1985, three years in 1995 and for a further five years in 1998. So, unless further extended, the scheme is scheduled to come to an end on June 30. On maturity, the amount under the scheme is payable in five equated annual instalments. The scheme is operated through various public sector banks (PSU banks) and the Reserve Bank of India (RBI) offices.

The SDS is a notional unassetised account in which retirement fund used to invest and were paid an interest equal to the benchmark rate for retirement funds. In 1997, SDS was frozen for new investments and has since been credited with the interest only. On an average, the SDS portion of investments is still to the tune of 50 per cent . The SDS book value to be repaid by the government to non-government retirement funds is estimated at Rs. 125,365 crores. SDS has not given any payouts except in case of specific requests, that is, to seek withdrawal as and when the contributions are not sufficient for settlements.

However, the maximum withdrawal from SDS can be in the proportions of investments (asset allocation) as existed in 1997 when SDS was locked.

Today there is a growing concern within the retirement benefit industry over this asset class and the negative impact it has on portfolio yields and term structure.

In the falling interest rate scenario the sooner this SDS money is instrumentalised and assetised, the greater the chance for provident funds to meet their duration needs, Mr. Mehta felt. Similar issues, which trouble provident and pension managers today, include not being allowed to swap their investments and introduction of duration based trading.

Although these funds make large and significant investments in government and quasi government paper, which have low or no ratings, they do not have a single risk management tool to meet changes in the issuer's financial health.

The share of investment must be increased for corporate paper as it would benefit the retirement trusts as a safe avenue for their investment. Financial market participants feel that the Government should move in the direction of granting exemptions to financially vibrant employers.

The Government holds huge funds of provident and pension funds. As a result, it has systematically mopped up a large fraction of savings and pre-empted these for its own purpose. It is the privatisation of this resource mobilisation effort that would have the most telling impact on our retirement funds.

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