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How pension funds can boost equity markets

How pension funds can boost equity markets
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First Published: Wed, Apr 18 2007. 01 08 AM IST
Updated: Wed, Apr 18 2007. 01 08 AM IST
The next few months will set the tone for the growth of Indian financial markets in years to come. If India can make a successful beginning with the proposed modernization of its pension industry, the market value of domestic stocks may well exceed $5 trillion in 2020, higher than that of Japan’s equities today.
That prediction is based on back-of-the-envelope calculations, taking into account the impact that old-age savings appear to have had on stock markets elsewhere in the world.
According to Helene Poirson, an economist at the International Monetary Fund, equity markets in the Group of Seven industrialized nations grew the equivalent of 40 percentage points of gross domestic product from 1980 to 1998, led by an increase in pension assets. Chile, too, witnessed a similar strong correlation between retirement savings and market value. There’s no reason the script should play out any differently in India. The size of the retirement market as a ratio of GDP is only a tenth as big as in Singapore, Japan and Malaysia, and a quarter as large as in Hong Kong, according to HSBC Holdings Plc.
Assuming that India’s $822 billion economy grows 8% a year with 5% inflation, a $5 trillion stock market should be within India’s reach in slightly more than a decade; as much as a fifth of it may be associated with larger flows of retirement funds into equities. In July, India will take a small yet significant step in this direction.
The task of ensuring old-age security for all Central government employees who joined after January 2004 will be handed over to three asset-management companies. The managers will be able to invest 5% of the money in equities and 10% in equity-linked mutual funds, D. Swarup, chairman of India’s Pension Fund Regulatory and Development Authority, said in New Delhi last week. The political consensus for a fuller liberalization of the pension industry still eludes. The legislation that will see all workers building nest eggs through 401(k)-type personal, portable accounts has been stuck in Parliament for more than two years because of staunch opposition from trade unions and the government’s Marxist backers. No one expects the impasse to end soon.
That’s because the Left parties and unions want every civil servant to continue to receive a guaranteed pension equal to half of their last-drawn pay. Never mind that these “defined- benefit” plans have been shown to be veritable time bombs for fiscal sustainability. By 2010, the annual budgetary outlay on government pensions in India will amount to 1.8% of GDP, or double what the government spends on health care.
So why should investors care about 5,00,000 “new” public servants migrating to an actively managed “defined-contribution” retirement plan from July?
That isn’t exactly critical mass in a country where the government alone has 17 million employees and the workforce is 400-million strong.
Besides, to begin with, pension-fund managers will be selected from within the state-run financial industry. Limited competition raises the specter of high fund-management fees and diminished returns for retirees.
Yet, for all its timidity, it’s a step in the right direction. Ajay Shah, a former consultant to the Union finance ministry, says India should move to a partially deregulated pension management industry within the ambit of the existing regulatory framework, rather than wait for the passage of a compromised pension-fund Bill.
Surveys have pointed to strong demand in India for long-term retirement products. Public servants who joined before 1984 have their guaranteed pensions. The hundreds of millions of workers toiling in the informal or unorganized economy have nothing at all. Stuck in between are the 40 million employees working in the non-state formal economy whose mandatory savings go to the state-run Employment Provident Fund, a defined-contribution plan that shuns equity and invests most of its money in sedate “special” government securities. It’s simply not a vehicle for providing meaningful, old-age security to anyone.
As income levels in India rise, people will increasingly look for investment options that marry present-day tax savings with serious long-term wealth creation. The urban affluent should be the logical target in expanding the scope of the new pension plan, which aims to offer—to those who have the appetite for risk—a maximum of 50% exposure to stocks.
What will all this mean for Indian equities?
By the late 1990s, much of the regulatory work in improving the efficiency and integrity of the stock market in India was complete. Yet, “it is only since 2003, when the GDP started growing at its current pace, that the large global investors became interested and poured money into it,” says a new report by Standard & Poor’s.
Growing overseas interest is only part of the equation. What’s still missing from the Indian equity market, as UTI Mutual Fund’s chief investment officer A.K. Sridhar said late last year, is long-term domestic money. That’s where retirement funds will play a big role. The quest for old-age security has the power to deepen Indian equity markets. How the government goes about opening the industry in the next few months and years will be crucial
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First Published: Wed, Apr 18 2007. 01 08 AM IST
More Topics: Economy and Politics | Indicators |