India needs to save the day4 min read . Updated: 30 Jun 2013, 07:52 PM IST
A credible and widely subscribed savings vehicle may reduce the country’s fatal attraction for gold
India is one oil shock away from an old-fashioned, emerging market, balance of payments (BoP) crisis.
Despite nearly $300 billion of reserves built over the 20 years after economic reforms, we have come to this sorry state because of our continued external oil dependency, asinine policies and a fetish for gold. India’s short-term external debt has now risen to nearly 60% of reserves. Rolling over foreign currency debt at a time when the dollar is rising and dollar interest rates are jumping may put further pressure on the rupee. Much of the talk to prevent India from going over the cliff has been to adopt tactical measures to reduce the import of gold and to revitalize foreign direct investment (FDI) interest in India.
Much less attention has been paid to implementing a comprehensive framework for a pension system in India. A robust, large, local savings pool does not directly impact the BoP calculation. But it has a material indirect impact. This savings pool reduces India’s addiction to external capital for investment projects. By keeping its investments going at a time of external stress, India can attract foreign capital (both FDI and capital flows) more readily than it does now. This, in turn, serves to alleviate the pressure on the BoP. A credible and widely subscribed savings vehicle may also reduce the country’s fatal attraction for gold.
India is one of the few countries that does not have a population-wide old-age social security scheme. Two systems with narrow footprints exist at present—the government defined benefit scheme covering about 25 million civil servants, and private sector employees covered by the Employees’ Provident Fund Organization (EPFO), which caters to about 20 million people. Paradoxically, comprehensive framework regulation for the pension sector was tabled 10 years ago. A Pension Fund Regulatory and Development Authority (PFRDA) was set up at that time. PFRDA has established a National Pension Scheme (NPS) that today covers new government employees of 26 states (states are free to choose) and the Union government in a fully funded, defined contribution format. Individuals and corporates can voluntarily elect to become members of the NPS. The revised 2011 PFRDA Bill is still pending in Parliament.
The Indian pension story is extremely complex because nearly 92% of India’s workforce of 500 million people works in the informal sector. This makes it difficult to track workers, and to encourage, incentivize or enforce savings. In other countries, workers are encouraged to save most often by the deferment of taxes on the savings amount and on returns until retirement or withdrawal. As the NPS does, workers elsewhere are incentivized to save with matching contributions. In a few countries such as Singapore, workers are forced to save a portion of their wages in a national savings vehicle. In addition, until recently, there has been no way to identify individuals uniquely. This constraint has meant that the success of a system based on an individual, rather than on an entity (government or corporation) that they are or have been a part of, has not so far been possible. Despite a match of a thousand rupees from the government, the number of self-employed workers who have become a part of the NPS since 2009 is pathetically small.
The primary rationale for creating pension systems has been income security for the elderly as a country matures. While this is the right motivation, a large pension system has major aggregate benefits as well. One mechanism by which a benefit accrues is that institutional investors like pension funds, insurance companies and mutual funds channel long-term savings to investments and another is that they nurture the development of various instruments and markets of return and risk like equities, corporate bonds, institutional real estate, domestic venture capital, and interest rate and currency derivatives.
What can be done? First, the PFRDA Bill should be passed. A system-wide initiative to coordinate the local capital deepening activities of regulators, (PFRDA, Securities and Exchange Board of India) industry bodies (Association of Mutual Funds in India, Indian Private Equity and Venture Capital Association, Confederation of Real Estate Developers’ Associations of India) and policymakers (finance and labour ministries) should be undertaken. It should be focused on both the macro (benefits to the economy) and the micro (benefits to a citizen). With the steadily increasing footprint of Aadhaar unique identity system, a national pensions framework anchored on the individual has become possible. It should remove speed bumps in the wide acceptance of the NPS. The NPS should fully adopt Aadhaar as the relational identifier. An exchange-traded fund created from the sale of government ownership in companies should be one way by which a match is offered to those who subscribe to the NPS.
Parliamentarians and officials are asleep at the switch on passing and implementing pension fund regulation in India. They need to rise and save the day. Otherwise, India will grow old, waiting.
PS: Albert Einstein is rumoured to have said that “compound interest is the greatest of man’s inventions". As you grow old, tax-deferred financial compounding will allow a measure of income security.
Narayan Ramachandran is chairman, InKlude Labs. Comments are welcome at firstname.lastname@example.org
To read Narayan Ramachandran’s previous columns, go to www.livemint.com/avisiblehand-