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Business News/ Opinion / Columns/  State elections and the troubling return of the old pension scheme

State elections and the troubling return of the old pension scheme

The current spate of states reverting to it poses a fiscal threat with serious portents for the financial stability of the country

State governments shifted along with the central government out of the OPS to the new pension scheme (NPS) without any coercion, because they saw the sense of it. (mint)Premium
State governments shifted along with the central government out of the OPS to the new pension scheme (NPS) without any coercion, because they saw the sense of it. (mint)

There is a tug of war currently underway, one side restraining inflation, the other side pulling not to restrain gross domestic product (GDP), in India as elsewhere. In these circumstances, it is important to head off developments which could endanger financial stability in the medium term.

Prominent among them are the poll promises in ongoing state elections. The Congress manifesto for the Himachal Pradesh election promises that if voted to power, it will revert at the very first sitting of the cabinet to the old pension scheme (OPS) for state government employees. Polling in Himachal Pradesh state is over, but the results are yet to be declared. The Gujarat state election is on this month, and nine state elections will follow in calendar 2023.

The OPS was a defined-benefit scheme with an entitlement defined (by the fifth pay commission) at 50% of the last salary drawn. The OPS became uniquely burdensome on the fisc because, in addition to (entirely reasonable) inflation indexation through dearness allowance adjustments, it was wage indexed to pay-scale revisions prescribed by successive pay commissions.

State governments shifted along with the central government out of the OPS to the new pension scheme (NPS) without any coercion, because they saw the sense of it. This shift happened in all states barring one (West Bengal) at various points during the year 2004. The NPS, like pension systems elsewhere in the world, is based on the amounts contributed by the employee and employer over the working life of the employee, and the market yield obtained on the consolidated pension fund. The NPS is regulated by the Pension Fund Regulatory and Development Authority (PFRDA). Pensions for defence personnel, paid by the central government, were the sole exemption from this shift, and continue to be paid on the defined-benefit system.

The OPS, by virtue of benefits definitionally unrelated to past contributions of pensioners during their working lives, needs financial support from contributions of current working employees. Like all such pay-as-you-go schemes, as the number of pensioners and benefits due to them grow, relative to the numbers paying in, it could reach a point where the alternatives are defaulting on pensions due or unsustainable borrowing.

Before the Himachal manifesto, three state governments had already notified the PFRDA of their switch to the OPS: Chhattisgarh and Rajasthan (with effect from 1 April 2022), and Jharkhand (1 October 2022). Chhattisgarh and Rajasthan both have Congress governments, and Jharkhand has a coalition led by the Jharkhand Mukti Morcha (JMM), which includes the Congress party. For the JMM, it was a poll promise, but the Congress party in the other two states did not promise the OPS in their manifestos for the previous 2018 state elections.

The stampede towards an exit from the NPS is thus a new phenomenon. It was probably triggered by the victory in March 2022 of the Aam Aadmi Party (AAP) in the Punjab state election, which, wholly erroneously, was attributed to AAP’s promised return to the OPS. Elections are not a one-issue referendum. The AAP manifesto for Punjab promised many things, but of those in the pension sphere, only the fivefold increase in old age, handicapped and widow pensions would have carried traction with the ordinary (aam) Punjab voter. Other poll promises with similarly broad appeal would have been abolition of mafias and the drug trade, free medical facilities, and freeing farmers from debt.

Reverting to the OPS cannot possibly carry widespread voter appeal. For the median voter, the OPS should on the contrary be a red flag since it squeezes the exchequer from which welfare benefits flow to the common person. The OPS benefits only retirees, and should not even enthuse current employees, because the state government is likely to become insolvent by the time their defined benefits become due.

In the event, when the new AAP government assumed power and saw the sorry state of Punjab finances, which made even the payment of current employee salaries a challenge, an exit from the NPS was not immediately notified. It was finally announced in October 2022, perhaps to lend credence to the AAP poll promises for Himachal Pradesh and Gujarat.

There have been suggestions that the Election Commission should require any party manifesto promise with financial implications to quantify its impact on state finances. The Commission cannot sit in judgement over those numbers, or penalize non-compliance, but a requirement of that nature can be a powerful disciplining force. Even if a party fails to quantify its promises, a rival party can do the calculations and mount a more effective electoral challenge. The electoral debate will become more meaningful than it presently is.

A return to the OPS is not the only damaging promise. The AAP manifesto for Punjab promises to abolish property tax, the only significant source of own revenue leviable by municipalities. Municipalities and panchayats in India are subject to legislation passed at the state level. Unless third-tier governments receive compensating transfers from the state exchequer, roads and sanitation, municipal school teacher salaries and public health services are all in danger of cutbacks.

The Election Commission alone can ensure that fiscal responsibility becomes an election issue.

Indira Rajaraman is an economist


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Published: 01 Dec 2022, 08:47 PM IST
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